Practice Questions 2 For Mid - Term Exam

Practice Questions for Elasticity of Demand and Supply
1. Graph the accompanying demand data, and then use the midpoint formula for Ed to
determine price elasticity of demand for each of the four possible $1 price changes. What
can you conclude about the relationship between the slope of a curve and its elasticity?
Explain in a nontechnical way why demand is elastic in the northwest segment of the
demand curve and inelastic in the southeast segment.
Product Quantity
Price demanded
$5 1
4 2
3 3
2 4
1 5
Answers: See the graph accompanying the answer to Question 2. Elasticities, top to
bottom: 3; 1.4; .714; .333. Slope does not measure elasticity. This demand curve has a
constant slope of -1 (= -1/1), but elasticity declines as we move down the curve. When
the initial price is high and initial quantity is low, a unit change in price is a low
percentage while a unit change in quantity is a high percentage change. The percentage
change in quantity exceeds the percentage change in price, making demand elastic.
When the initial price is low and initial quantity is high, a unit change in price is a high
percentage change while a unit change in quantity is a low percentage change. The
percentage change in quantity is less than the percentage change in price, making demand
inelastic.
2. Calculate total-revenue data from the demand schedule in question 1. Graph total
revenue below your demand curve. Generalize about the relationship between price
elasticity and total revenue.
Answers: See the graph. Total revenue data, top to bottom: $5; $8; $9; $8; $5. When
demand is elastic, price and total revenue move in the opposite direction. When demand
is inelastic, price and total revenue move in the same direction.
3. How would the following changes in price affect total revenue? That is, would total
revenue increase, decline, or remain unchanged?
a. Price falls and demand is inelastic.
b. Price rises and demand is elastic.
c. Price rises and supply is elastic.
d. Price rises and supply is inelastic.
e. Price rises and demand is inelastic.
f. Price falls and demand is elastic.
g. Price falls and demand is of unit elasticity.
Answers: Total revenue would increase in (c), (d), (e), and (f); decrease in (a) and (b);
and remain the same in (g).
4. What are the major determinants of price elasticity of demand? Use those determinants
and your own reasoning in judging whether demand for each of the following products is
probably elastic or inelastic:
(a) bottled water; (b) toothpaste; (c) Crest toothpaste; (d) ketchup; (e) diamond bracelets;
(f) Microsoft Windows operating system.
Answers: Substitutability, proportion of income; luxury versus necessity, and time.
Elastic: (a), (c), (e). Inelastic: (b), (d), and (f).
5. What is the formula for measuring the price elasticity of supply? Suppose the price of
apples goes up from $20 to $22 a box. In direct response, Goldsboro Farms supplies
1200 boxes of apples instead of 1000 boxes. Compute the coefficient of price elasticity
(midpoints approach) for Goldsboro’s supply. It its supply elastic, or is it inelastic?
Answers: Es = percentage change in quantity supplied / percentage change in price.
Using the midpoint formula, Es = 1.91 {= (200/[(1000+1200)/2] / 2/[(20+22)/2]}
Supply is price elastic (Es>1).
6. Suppose the cross elasticity of demand for products A and B is +3.6 and for products C
and D is -5.4. What can you conclude about how products A and B are related? Products
C and D?
Answers: A and B are substitutes; C and D are complements.
7. The income elasticities of demand for movies, dental services, and clothing have been
estimated to be +3.4, +1.0, and +0.5 respectively. Interpret these coefficients. What does
it mean if the income elasticity coefficient is negative?
Answers: All are normal goods—income and quantity demanded move in the same
direction. These coefficients reveal that a 1 percent increase in income will increase the
quantity of movies demanded by 3.4 percent, of dental services by 1.0 percent, and of
clothing by 0.5 percent. A negative coefficient indicates an inferior good—income and
quantity demanded move in the opposite direction.
8. Use the ideas of consumer surplus and producer surplus to explain why economists say
competitive markets are efficient. Why are below- or above-equilibrium levels of output
inefficient, according to these two sets of ideas?
Answers: When the consumers’ utility exceeds the price paid, consumer surplus is
generated. Likewise, when producers receive a price greater than marginal cost, producer
surplus is created. By producing up to the point where MB = MC, the maximum
potential consumer surplus and producer surplus is generated. Producing less than the
equilibrium level means that potential surplus is left unrealized. Overproduction
subtracts from the surplus because society values the use of the additional resources in
other pursuits more than it values them in consumption of that good.

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Practice Questions for Elasticity of Demand and Supply

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