Economics: Elasticity & Revenue

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Questions and Answers

What can be inferred if the price elasticity of demand (PED) is greater than 1?

Demand is unitary elastic.

Total revenue will always increase.

Demand is elastic. (correct)

Demand is inelastic.

What happens to total revenue when the price of a good with inelastic demand increases?

Total revenue remains constant.

Total revenue fluctuates unpredictably.

Total revenue decreases.

Total revenue increases. (correct)

Which of the following correctly describes unitary elastic demand?

PED is less than 1.

PED equals 1. (correct)

PED is greater than 1.

Price changes do not affect quantity demanded.

In the Midpoint Method for calculating arc elasticity, what advantage does it provide?

It measures elasticity at a single point on the demand curve. Signup and view all the answers

What is the formula for calculating elasticity?

Elasticity (E) = % change in variable1 / % change in variable2 Signup and view all the answers

If the demand for a luxury good slightly decreases following a price increase, how would you classify its demand elasticity?

Elastic. Signup and view all the answers

If a product has a PED of 0.5, what can be inferred about its demand characteristics?

The product has inelastic demand. Signup and view all the answers

What does it indicate if the price elasticity of demand (PED) is greater than 1?

Demand is elastic. Signup and view all the answers

When the price of prescription medicines, known for inelastic demand, increases, what is the expected effect on quantity demanded?

Quantity demanded decreases slightly. Signup and view all the answers

Which method can be used to measure price elasticity of demand?

Arc Elasticity using the Midpoint Method Signup and view all the answers

If an increase in the price of a product leads to an increase in the quantity demanded, what can be said about the elasticity?

The elasticity is positive. Signup and view all the answers

In the context of price elasticity, what outcome can be expected when a good is said to have elastic demand?

A decrease in price will lead to higher total revenue. Signup and view all the answers

How is price elasticity of demand (PED) calculated using percentage changes?

PED = % change in quantity / % change in price Signup and view all the answers

What happens when the elasticity (E) is less than 1 in absolute value?

A percentage change in V2 results in a small change in V1. Signup and view all the answers

What does the equation % change in quantity = (QD2 – QD1) / QD1 represent?

The calculation for point elasticity. Signup and view all the answers

In the context of elasticity, what does it mean if E is negative?

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

What characteristic defines perfectly elastic demand?

Quantity demanded remains infinite at a set price. Signup and view all the answers

Which factor typically leads to more elastic demand?

Presence of many close substitutes. Signup and view all the answers

How does the time horizon affect demand elasticity?

Demand is elastic over longer time horizons. Signup and view all the answers

What type of goods typically exhibit inelastic demand?

Necessities such as food and water. Signup and view all the answers

Which scenario represents a consequence of elastic demand?

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

What role do economists play in relation to price elasticity of demand?

They estimate demand to inform business decision-making. Signup and view all the answers

What can managers use the price elasticity of demand to assess?

The impact of price changes on sales volume and revenues. Signup and view all the answers

What happens to demand when there are few close substitutes available?

Demand remains inelastic. Signup and view all the answers

What characterizes goods with perfectly inelastic demand?

They have an elasticity of zero. Signup and view all the answers

Which of the following statements is true for goods with inelastic demand?

They are considered necessities with an elasticity less than 1. Signup and view all the answers

How is unitary elastic demand defined?

Quantity demanded changes are equal to price changes. Signup and view all the answers

Which is an example of a factor affecting the price elasticity of demand?

The availability of substitutes for a product. Signup and view all the answers

What is a typical characteristic of a product with inelastic demand?

Consumers continue to purchase it even with price increases. Signup and view all the answers

Which statement describes a common misconception about perfectly inelastic demand?

It is possible for some goods to be perfectly inelastic. Signup and view all the answers

What is indicated by a steep demand curve?

The product has inelastic demand. Signup and view all the answers

What is the effect of a 25% increase in price for goods with unit elastic demand?

Demand decreases by 25%. Signup and view all the answers

Which of the following best describes a good with elastic demand?

The proportionate change in quantity demanded is greater than that of the price. Signup and view all the answers

Why should a company carefully assess its pricing strategy for unit elastic demand goods?

Substantial changes in price greatly impact quantity demanded. Signup and view all the answers

What defines goods and services with elastic demand?

Their elasticity is greater than 1. Signup and view all the answers

What is the recommended pricing strategy for goods with elastic demand?

Decrease prices to boost demand. Signup and view all the answers

How does a 25% increase in price affect goods with elastic demand according to the example provided?

Demand decreases by 50%. Signup and view all the answers

What is the characteristic of goods with perfectly elastic demand?

They have an infinite elasticity. Signup and view all the answers

What would most likely happen if a company selling elastic goods increases prices slightly?

Quantity demanded will decrease significantly. Signup and view all the answers

In the context of price elasticity, which scenario describes unit elastic demand?

A 10% increase in price leads to a 10% decrease in quantity demanded. Signup and view all the answers

Study Notes

Elasticity & Revenue

Elasticity measures the responsiveness of one variable to the change in another.
Elasticity (E) = % change in variable1 (V1) / % change in variable2 (V2)
Positive Elasticity means an increase in variable 2 leads to an increase in variable 1.
Negative Elasticity means an increase in variable 2 leads to a decrease in variable 1.
If E is greater than 1, a small % change in V2 leads to a greater change in V1.
If E is less than 1, a % change in V2 leads to a smaller change in V1.

Price Elasticity of Demand

Price Elasticity of Demand (PED) measures how much the quantity demanded of a good changes in response to a change in price.
PED can be calculated using Point Elasticity or Arc Elasticity (using the Midpoint Method).
Point Elasticity = % change in quantity / % change in price.
Arc Elasticity measures elasticity at the center of two points using the Midpoint Method (more precise).

Classifications of Price Elasticity of Demand

Elastic Demand: PED > 1; change in price leads to more than a proportional change in quantity demanded; total revenue increases when prices decrease. Examples: luxury goods, non-essential goods (wants).
Inelastic Demand: PED < 1; change in price leads to less than a proportional change in quantity demanded; total revenue decreases with higher prices. Examples: prescription medicine, essential goods (necessities).
Unitary Elastic Demand: PED = 1; change in price and quantity demanded are proportional; total revenue remains constant regardless of price changes. Examples: electricity, household appliances.

Graphical Representations of Price Elasticity of Demand

Perfectly Inelastic Demand: Elasticity = 0; quantity demanded remains the same despite price changes; does not exist in reality.
Inelastic Demand: Elasticity < 1; quantity demand changes minimally despite a large price change; steep demand curve compared to unitary elastic or elastic demand.
Unitary Elastic Demand: Elasticity = 1; proportionate change in quantity demanded with price change; changes in price will impact profitability.
Elastic Demand: Elasticity > 1; larger decrease in quantity demanded with price change; decrease prices to maximize demand.
Perfectly Elastic Demand: Elasticity = ∞; infinite demand at a fixed price; if companies maintain a fixed price, they have constant demand.

Importance of Price Elasticity of Demand

Knowing the value of PED is useful for companies, organizations, and the government.
PED can help determine pricing strategies, set production and sales goals to maximize profits.

What Affects Price Elasticity of Demand

Availability of substitutes: More available substitutes make demand more elastic; fewer substitutes make demand more inelastic.
Time horizon: Goods tend to have more elastic demand over longer time horizons because consumers have more time to adjust.
Necessities vs Luxuries: Necessities tend to have more inelastic demand, luxuries have more elastic demand.

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Description

This quiz delves into the concepts of elasticity and its impact on revenue in economics. It covers the definition and types of elasticity, particularly focusing on Price Elasticity of Demand and how it influences quantity demanded. Test your understanding of these fundamental economic principles and their applications.