Economics: Elasticity and Applications

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Questions and Answers

What best defines price elasticity of demand?

The degree to which quantity demanded changes due to a change in consumer income.

The effect of substitutes on quantity demanded.

The percentage change in quantity demanded in response to a percentage change in the price of the good. (correct)

The responsiveness of supply to changes in production costs.

Which factor tends to make demand more elastic?

The good is a necessity.

The demand is for a broadly defined market.

The good accounts for a small proportion of consumer income.

There are many close substitutes available. (correct)

In which scenario would you expect demand to be relatively inelastic?

When the good has many substitutes.

When the time period for analysis is prolonged.

When the good is defined broadly in the market. (correct)

When the good is a luxury.

How is price elasticity of demand computed?

By finding the percentage change in quantity demanded and dividing it by the percentage change in price. Signup and view all the answers

Which of the following would NOT increase the price elasticity of demand for a product?

Making the product a necessity. Signup and view all the answers

What impact does the proportion of income devoted to a product have on its demand elasticity?

Higher proportion of income increases elasticity. Signup and view all the answers

Which of the following statements about demand elasticity is FALSE?

Luxury goods generally have inelastic demand. Signup and view all the answers

What does the formula TR = P x Q represent?

Total Revenue as Price times Quantity Signup and view all the answers

When demand is price inelastic, what happens to total revenue when price increases?

Total revenue increases Signup and view all the answers

If the price increases from €1 to €3, how does total revenue change in the case of price inelastic demand?

It increases from €100 to €240 Signup and view all the answers

What happens to total revenue when price elastic demand is present and the price increases?

Total revenue decreases as quantity demanded falls more significantly Signup and view all the answers

Which of the following describes the relationship between price and quantity in the context of price elastic demand?

An increase in price leads to a larger decrease in quantity Signup and view all the answers

What is the formula for calculating Price Elasticity of Demand?

Percentage change in quantity demanded / Percentage change in price Signup and view all the answers

If the price elasticity of demand for a product is 0.5, what type of demand does this indicate?

Price inelastic demand Signup and view all the answers

In the example provided, how do you calculate the percentage change in quantity demanded when buying ice cream cones?

((10 - 8) / 10) * 100 Signup and view all the answers

What is indicated by perfectly price inelastic demand?

Quantity demanded remains unchanged despite price changes Signup and view all the answers

Which statement correctly describes unit price elastic demand?

Quantity demanded changes by the same percentage as the price Signup and view all the answers

If a product is said to have price elastic demand, what does that mean?

Quantity demanded responds strongly to price changes Signup and view all the answers

To compute the elasticity of demand, what do you divide the percentage change in quantity demanded by?

Percentage change in price only Signup and view all the answers

In which case would you expect the demand to be perfectly price elastic?

When there are many substitutes available Signup and view all the answers

Which of the following accurately describes a price inelastic demand curve?

Steeper slope, indicating less responsiveness to price Signup and view all the answers

What does a price elasticity of demand equal to 0 indicate?

Demand does not change with price fluctuations. Signup and view all the answers

If the price elasticity of demand is greater than 1, what can be inferred about demand?

Demand is price elastic. Signup and view all the answers

What percentage decrease in quantity demanded results from a 22% increase in price when demand is price inelastic?

11% Signup and view all the answers

Which of the following statements is true regarding unit elastic demand?

Price elasticity of demand equals 1. Signup and view all the answers

What happens to total revenue when demand is price elastic and the price is increased?

Total revenue decreases. Signup and view all the answers

If a 22% price increase leads to no change in quantity demanded, how is demand characterized?

Perfectly inelastic. Signup and view all the answers

What elasticity value indicates that a 1% price change results in a 1% quantity change?

1 Signup and view all the answers

In price inelastic demand, what best describes the relationship between price change and quantity demanded?

Quantity demanded changes less than the price change. Signup and view all the answers

What characterizes demand as perfectly elastic?

An elasticity of infinity. Signup and view all the answers

If a good has a price elasticity of 3, how is the demand for that good characterized?

Price elastic. Signup and view all the answers

What occurs when there is a 22% increase in price?

Quantity demanded decreases by 67% Signup and view all the answers

Which statement describes perfectly price elastic demand?

Consumers will buy any quantity at a specific price point. Signup and view all the answers

What happens to total revenue if the price is increased for a product with demand elasticities greater than 1?

Total revenue decreases. Signup and view all the answers

If total expenditure is calculated by multiplying price and quantity purchased, what does total revenue represent?

The price times the quantity sold. Signup and view all the answers

What is the elasticity of demand when price elasticity is greater than 1?

Elastic demand. Signup and view all the answers

At a price of exactly €4 in a perfectly elastic demand scenario, what is the quantity demanded?

Any quantity can be demanded. Signup and view all the answers

What is the effect of a price decrease below €4 for a perfectly elastic demand?

Quantity demanded becomes infinite. Signup and view all the answers

What does a drastic decrease in quantity demanded indicate about price elasticity?

Demand is elastic. Signup and view all the answers

In economic terms, how is total expenditure calculated?

Quantity demanded times unit price. Signup and view all the answers

Which scenario demonstrates price elasticity of demand being greater than 1?

A decrease in price results in a significant increase in quantity demanded. Signup and view all the answers

Study Notes

Elasticity and Its Applications

Elasticity allows for more precise analysis of supply and demand.
It measures how buyers and sellers react to market changes.

Demand Elasticity

Measures the sensitivity of quantity demanded to factors like price, income, and related goods.
Types of demand elasticity include:
- Price elasticity of demand
- Income elasticity of demand
- Cross-price elasticity of demand

Price Elasticity of Demand

Measures how much quantity demanded of a good changes in response to a change in its price.
Calculated as the percentage change in quantity demanded divided by the percentage change in price.
Formula: Ep = (%∆Q)/ (%∆P)
Determinants of price elasticity of demand include:
- Availability of close substitutes
- Whether the good is a necessity or a luxury
- Definition of the market
- Proportion of income devoted to the product
- Time horizon

Computing Price Elasticity of Demand

Calculated as the percentage change in quantity demanded divided by the percentage change in price.
Example: If the price of an ice cream cone rises from €2.00 to €2.20, and the quantity demanded falls from 10 cones to 8 cones, the elasticity of demand is 2.

Using the Point Elasticity of Demand Method

Formula: Price elasticity of demand = (P/Qd) x (1/ΔP/ΔQd)

The Variety of Demand Curves

Price Inelastic Demand: Quantity demanded is not greatly affected by price changes, elasticity is less than 1.
Price Elastic Demand: Quantity demanded changes considerably with price changes, elasticity is greater than 1.
Perfectly Price Inelastic: Quantity demanded stays constant regardless of price changes.
Perfectly Price Elastic: Quantity demanded changes infinitely with any change in price.
Unit Price Elastic: Quantity demanded changes by the same percentage as the price.

Computing the Price Elasticity of Demand

Example showing a graph, and explanation showing how the price elasticity of demand is price elastic.

Figure 1a: Perfectly Price Inelastic Demand

A price increase does not change the quantity demanded.

Figure 1b: Price Inelastic Demand

A price increase causes a smaller decrease in quantity demanded.

Figure 1c: Unit Elastic Demand

A price increase causes an equal percentage decrease in quantity demanded.

Figure 1d: Price Elastic Demand

A price increase causes a larger percentage decrease in quantity demanded.

Figure 1e: Perfectly Price Elastic Demand

Any price above a certain level leads to zero demand; at that exact level, any quantity is demanded.

Total Expenditure, Total Revenue, and Price Elasticity of Demand

Total expenditure: Amount paid by buyers (price x quantity).
Total revenue: Amount paid by buyers and received by sellers (price x quantity).

Figure 2: Total Revenue

Graph demonstrating total revenue as a function of quantity demanded.

Figure 3: Price Inelastic Demand

An increase in price leads to a smaller decrease in quantity demanded, thus increasing total revenue.

Figure 4: Price Elastic Demand

An increase in price leads to a larger decrease in quantity demanded, thus decreasing total revenue.

Price Elasticity of a Linear Demand Curve

Slope of a linear demand curve is constant, but elasticity varies along the curve.
Elasticity is inelastic at low prices and high quantities, and elastic at high prices and low quantities.
Total revenue varies at different points along the demand curve.

Price Elasticity of a Linear Demand Curve.

Demand curve is a straight line.
Elasticity depends on the slope of the demand curve and on price & quantity.
Elasticity varies along the curve as price & quantity change.
Elasticity is large at the top of the curve (high prices, low quantities) and becomes smaller at the bottom

Other Demand Elasticities

Income elasticity of demand: Percentage change in quantity demanded resulting from a 1% increase in income.
Cross-price elasticity of demand: Percentage change in quantity demanded for one good resulting from a 1% increase in the price of another good.

Income Elasticity of Demand

Percentage change in quantity demanded related to a 1% increase in income.
Higher necessity (food, medicine) goods show lower income elasticity.
Luxury goods have higher income elasticity.

Cross-price Elasticity of Demand

Percentage change in quantity demanded for a good related to a 1% increase in price of another good.
Positive cross-price elasticity indicates substitutes (e.g., tea and coffee).
Negative cross-price elasticity indicates complements (e.g., coffee and milk).

The Price Elasticity of Supply

Measures how much the quantity supplied of a good responds to a change in its price.
Calculated as the percentage change in quantity supplied divided by the percentage change in price.
Types: Perfectly price inelastic, price inelastic, unit elastic, price elastic, and perfectly price elastic supply.

Summary

Price elasticity of demand measures the responsiveness of quantity demanded to price changes.
Elastic demand means total revenue falls with price increases, whereas inelastic demand means total revenue rises with price increases.
Income elasticity measures the effect of income changes on demand, with higher income elasticity for luxury goods.
Cross-price elasticity measures the effect of one price change on the demand for another good.
Price elasticity of supply measures the responsiveness of quantity supplied to price changes, with supply often more elastic in the long-run.

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Description

This quiz explores the concept of elasticity in economics, focusing on its applications to supply and demand analysis. You'll learn about various types of demand elasticity, including price, income, and cross-price elasticity, and how to calculate them. Test your understanding of the factors that influence the elasticity of demand.