Price Elasticity of Demand
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Questions and Answers

If a consumer's income increases by 10% and their quantity demanded of a good increases by 5%, what is the income elasticity of demand for that good?

  • 0.5 (correct)
  • 2.0
  • -0.5
  • -2.0

    • Which of the following is most likely to have a negative income elasticity of demand?

  • Gourmet Coffee
  • Designer Clothing
  • Organic Vegetables
  • Public Transportation (correct)

    • Which of the following goods is most likely to have a high income elasticity of demand?

  • Household cleaning supplies
  • Basic staple foods
  • Luxury vacation packages (correct)
  • Essential medications

    • If the cross-price elasticity of demand between two goods is positive, how are the goods related?

    <p>They are substitutes. (C)</p> Signup and view all the answers

    Suppose the price of coffee increases by 10%, and the quantity demanded of tea increases by 15%. What is the cross-price elasticity of demand, and what does it indicate?

    <p>1.5, substitutes (B)</p> Signup and view all the answers

    If the price elasticity of demand is exactly 1, what does this indicate about the relationship between the percentage change in quantity demanded and the percentage change in price?

    <p>The percentage change in quantity demanded equals the percentage change in price. (B)</p> Signup and view all the answers

    How does the slope of a demand curve relate to the price elasticity of demand at a given point?

    <p>The flatter the demand curve, the greater the price elasticity of demand. (C)</p> Signup and view all the answers

    In the case of perfectly inelastic demand, what is the shape of the demand curve and the value of the elasticity?

    <p>Vertical, elasticity is zero (D)</p> Signup and view all the answers

    Based on the supply curve provided, what happens to the quantity supplied when the price is exactly $4?

    <p>Producers will supply any quantity. (D)</p> Signup and view all the answers

    What does it mean for demand to be perfectly elastic, and what is the shape of the corresponding demand curve?

    <p>Small price changes lead to huge quantity changes; horizontal. (D)</p> Signup and view all the answers

    If a good has a price elasticity of demand greater than 1, what happens to total revenue if the price decreases?

    <p>Total revenue increases. (C)</p> Signup and view all the answers

    According to the graph, what is the percentage increase in quantity supplied when there is a 22% increase in price, as indicated?

    <p>67% increase in quantity supplied. (B)</p> Signup and view all the answers

    If the market price of a good is above $4, according to the supply curve, what is the quantity supplied?

    <p>Infinite (C)</p> Signup and view all the answers

    Assume the price of gasoline increases by 10%, and the quantity demanded decreases by 5%. What type of price elasticity of demand does gasoline have?

    <p>Inelastic (D)</p> Signup and view all the answers

    Under what condition would a company consider lowering its prices to increase total revenue?

    <p>When demand is elastic and a price decrease leads to a proportionally larger increase in quantity demanded. (A)</p> Signup and view all the answers

    How do economists estimate the price elasticity of demand for specific goods in the real world?

    <p>By collecting data from market outcomes and applying statistical techniques. (B)</p> Signup and view all the answers

    If demand is unit elastic and a company raises its prices, what happens to total revenue?

    <p>Total revenue remains constant. (A)</p> Signup and view all the answers

    According to the information, what is the quantity supplied at a price below $4?

    <p>Zero (B)</p> Signup and view all the answers

    Why does elasticity change along a linear demand curve, even though the slope is constant?

    <p>Because the slope is the ratio of absolute changes, while elasticity is the ratio of percentage changes. (D)</p> Signup and view all the answers

    For a product with perfectly inelastic demand, such as a life-saving drug where no substitutes exist, what is the most likely impact of a significant price increase on the quantity demanded?

    <p>Quantity demanded will remain relatively constant. (B)</p> Signup and view all the answers

    Why might good news for Kansas wheat farmers, such as increased wheat production, potentially lead to bad economic outcomes for them?

    <p>Increased supply could lead to a decrease in the overall market price of wheat, reducing revenue. (B)</p> Signup and view all the answers

    Which economic principle is most directly applicable when analyzing the effects of increased wheat production on farmers' income?

    <p>Law of supply and demand (A)</p> Signup and view all the answers

    On a linear demand curve, if a $1 decrease in price leads to a 2-unit increase in quantity demanded, what remains constant?

    <p>The slope of the demand curve (D)</p> Signup and view all the answers

    Based on the applications mentioned, what common factor links seemingly unrelated issues like farming, OPEC's oil pricing, and drug-related crime?

    <p>The forces of supply and demand in markets (B)</p> Signup and view all the answers

    If the price elasticity of demand for a product is greater than 1, what can be inferred about the relationship between price changes and total revenue?

    <p>Price and total revenue move in opposite directions. (B)</p> Signup and view all the answers

    A store owner notices that when they increase the price of their by 10%, their total revenue decreases. What does this indicate about the demand for their ?

    <p>The demand is elastic. (A)</p> Signup and view all the answers

    A Kansas wheat farmer is trying to improve the productivity of their land. According to the text, what is the farmer primarily motivated by?

    <p>Earning income from selling wheat. (D)</p> Signup and view all the answers

    Consider a product with a linear demand curve. At which point on the curve is the price elasticity of demand likely to be the highest?

    <p>At the point closest to the price axis. (A)</p> Signup and view all the answers

    A company is considering whether to lower the price of its product. Which of the following factors is most critical in making this decision?

    <p>The price elasticity of demand. (D)</p> Signup and view all the answers

    Using the midpoint method, what is the price elasticity of demand for business travelers when the price of airline tickets rises from $200 to $250?

    <p>0.22 (A)</p> Signup and view all the answers

    Using the midpoint method, what is the price elasticity of demand for vacationers when the price of airline tickets rises from $200 to $250?

    <p>2.63 (C)</p> Signup and view all the answers

    Why might vacationers have a different price elasticity of demand for airline tickets compared to business travelers?

    <p>Vacationers often have more flexible travel schedules and are more sensitive to price changes than are business travelers. (A)</p> Signup and view all the answers

    Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run. If the price of heating oil rises from $1.80 to $2.20 per gallon, what is the approximate percentage decrease in the quantity of heating oil demanded in the short run?

    <p>4% (A)</p> Signup and view all the answers

    Assume coffee and donuts are complementary goods. If severe weather in Brazil damages a large portion of the coffee bean crop, what is most likely to happen to the equilibrium price and quantity of donuts?

    <p>Price and quantity both decrease (B)</p> Signup and view all the answers

    The price of coffee rose sharply last month, while the quantity sold remained the same. Which of the following explanations is consistent with this observation?

    <p>Demand increased, and supply was perfectly inelastic. (A)</p> Signup and view all the answers

    The price of coffee rose sharply last month, while the quantity sold remained the same. Which of the following could also explain this observation?

    <p>Demand increased, and supply decreased at the same time. (A)</p> Signup and view all the answers

    What does it indicate when the price elasticity of supply approaches infinity?

    <p>Small changes in price lead to very large changes in quantity supplied. (B)</p> Signup and view all the answers

    Why might the elasticity of supply vary along the supply curve for an industry with firms operating factories at limited capacity?

    <p>Firms initially have idle capacity but eventually reach full capacity. (C)</p> Signup and view all the answers

    In the described scenario, when the price rises from $3 to $4, the quantity supplied increases significantly. What does this indicate about the supply curve's elasticity in this range?

    <p>The supply curve has an elasticity greater than 1. (D)</p> Signup and view all the answers

    When production capacity is fully used, what must happen to induce firms to increase production further?

    <p>The price must rise substantially to justify new investments. (D)</p> Signup and view all the answers

    Consider an industry where firms initially have high elasticity of supply. What is the most likely reason for this high elasticity?

    <p>Firms have significant idle resources that can easily be utilized. (B)</p> Signup and view all the answers

    If a firm is operating close to its maximum production capacity, how would you expect its price elasticity of supply to change compared to when it was operating with significant idle capacity?

    <p>It would decrease because the firm faces higher costs to increase production. (B)</p> Signup and view all the answers

    In a scenario where the price elasticity of supply is greater than 1, what can be generally inferred about the responsiveness of quantity supplied to price changes?

    <p>Quantity supplied is proportionately more responsive than price. (A)</p> Signup and view all the answers

    What is the likely outcome in a market where firms have fully utilized their production capacity and the price elasticity of supply is very low?

    <p>Significant price increases are required to elicit even small increases in quantity supplied. (C)</p> Signup and view all the answers

    Flashcards

    Unit Elasticity

    When the percentage change in quantity equals the percentage change in price.

    Price Elasticity of Demand

    Measures how much quantity demanded responds to price changes.

    Demand Curve Slope

    The angle of the demand curve determining price elasticity.

    Perfectly Inelastic

    Demand remains constant regardless of price changes; represented by a vertical curve.

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    Perfectly Elastic

    Very small price changes lead to massive changes in quantity demanded; represented by a horizontal curve.

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    Flatter Demand Curve

    Indicates a greater price elasticity of demand.

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    Steeper Demand Curve

    Indicates a smaller price elasticity of demand.

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    Estimating Elasticity

    Economists collect data and use statistics to estimate price elasticity of demand.

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    Income Elasticity of Demand

    Measures how quantity demanded changes with consumer income changes.

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    Normal Goods

    Goods for which demand increases as consumer income rises.

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    Inferior Goods

    Goods for which demand decreases as consumer income rises.

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    Cross-Price Elasticity of Demand

    Measures how quantity demanded of one good changes when the price of another good changes.

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    Necessities vs. Luxuries

    Necessities have low income elasticity; luxuries have high income elasticity.

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    Price Elasticity of Supply

    Measures the responsiveness of quantity supplied to price changes.

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    Infinite Elasticity

    Occurs when the supply curve is horizontal, indicating very high responsiveness to price changes.

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    Limited Capacity in Production

    Refers to firms having production limits that affect how they respond to price changes.

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    Idle Capacity

    Unutilized resources in production that can be activated if prices rise.

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    Elasticity Greater than 1

    Indicates quantity supplied changes more than price changes, often at lower production levels.

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    Elasticity Less than 1

    Indicates quantity supplied changes less than price changes, often at higher production levels.

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    Price Changes Impact

    Shows how significant price increases affect quantity supplied differently based on production levels.

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    Building New Plants

    Firms need to raise prices substantially to justify the expense of expanding production capacity.

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    Elastic Demand

    Demand is elastic when price elasticity is greater than 1.

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    Inelastic Demand

    Demand is inelastic when price elasticity is less than 1.

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    Unit Elastic Demand

    Demand is unit elastic when price elasticity equals 1.

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    Total Revenue Impact (Elastic)

    If price increases, total revenue decreases when demand is elastic.

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    Total Revenue Impact (Inelastic)

    If price increases, total revenue increases when demand is inelastic.

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    Linear Demand Curve Slope

    The slope of a linear demand curve is constant (rise/run).

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    Elasticity versus Slope

    Elasticity measures percentage changes, while slope measures absolute changes.

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    Price Change Effects

    Price changes affect total revenue differently based on elasticity type.

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    Price Elasticity of Demand for Business Travelers

    Measures the responsiveness of business travelers' ticket demand to price changes.

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    Price Elasticity of Demand for Vacationers

    Measures the responsiveness of vacationers' ticket demand to price changes.

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    Difference in Elasticity

    Vacationers may be more price sensitive due to leisure priorities versus business urgency.

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    Price Increase Effect on Heating Oil

    If heating oil price rises, short-term demand decreases slightly due to low elasticity.

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    Short Run vs Long Run Elasticity

    Short run elasticity for heating oil is 0.2, long run is 0.7, indicating higher sensitivity over time.

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    Demand Increase and Supply

    The price of coffee can rise if demand increases while supply remains unchanged or decreases.

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    Total Expenditure and Price Changes

    When prices rise, total expenditure on coffee changes depending on elasticity: elastic demand decreases total outlay, inelastic increases it.

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    Perfectly Inelastic Supply

    When the price of coffee rises, but quantity supplied does not change, it's perfectly inelastic supply.

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    Supply at $4

    At a price of $4, producers will supply any quantity demanded.

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    Infinite Supply

    When the price is above $4, quantity supplied becomes infinite.

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    Quantity Supplied at $4

    At $4, producers will supply any amount of products.

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    Price Increase Impact

    An increase in price leads to a 67% increase in quantity supplied.

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    Supply Below $4

    At a price below $4, quantity supplied is zero.

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    Elasticity in Markets

    Elasticity measures how much quantity responds to price changes.

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    Market Forces

    All markets operate under the influence of supply and demand.

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    Good News for Farmers

    Good news in farming could negatively impact farm income.

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    Study Notes

    Elasticity and Its Application

    • Elasticity measures how buyers and sellers respond to market changes.
    • Elasticity is a measure of responsiveness to changes in price, quantity demanded, or income.
    • Price elasticity of demand measures how quantity demanded responds to price changes.
    • Elastic demand: Quantity demanded responds substantially to price changes.
    • Inelastic demand: Quantity demanded responds minimally to price changes.
    • Availability of close substitutes affects demand elasticity. Goods with many substitutes exhibit higher elasticity.
    • Necessities tend to have inelastic demand (e.g., doctor visits).
    • Luxuries tend to have elastic demand (e.g., sailboats).
    • The time horizon influences elasticity; demand is more elastic in the long run.
    • The midpoint method calculates percentage changes, preventing base-related discrepancies when calculating elasticity.

    The Price Elasticity of Demand

    • The law of demand states that lower prices lead to higher quantities demanded.
    • The price elasticity of demand quantifies this responsiveness.
    • Elastic demand: A substantial change in quantity demanded in response to a small price change.
    • Inelastic demand: A small change in quantity demanded in response to a large price change.
    • Close substitutes lead to more elastic demand.
    • Necessities generally have inelastic demand.
    • Luxuries generally have elastic demand.
    • The longer the time period, the more elastic the demand.

    Computing the Price Elasticity of Demand

    • Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price.
    • Example: A 10% price increase leads to a 20% decrease in quantity demanded, resulting in an elasticity of 2.
    • The formula considers the midpoint method for more accurate percentage change calculations.

    The Variety of Demand Curves

    • Demand curves are classified according to their elasticity.
    • Perfectly inelastic demand: Quantity demanded remains constant regardless of price (vertical curve).
    • Inelastic demand: Quantity demanded changes less than proportionately to price changes (relatively steep curve).
    • Unit elastic demand: Quantity demanded changes proportionately to price changes (slope is neither steep nor flat).
    • Elastic demand: Quantity demanded changes more than proportionately to price changes (relatively flat curve).
    • Perfectly elastic demand: Any price change results in infinite/zero quantity demanded (horizontal curve).

    Total Revenue and the Price Elasticity of Demand

    • Total revenue (TR) is price (P) multiplied by quantity (Q).
    • For inelastic demand, price and total revenue move in the same direction.
    • For elastic demand, price and total revenue move in opposite directions.
    • For unit elastic demand, total revenue remains constant when prices change.

    Other Demand Elasticities

    • Income elasticity of demand measures how quantity demanded changes with income changes.
      • Normal goods: Increase in income leads to an increase in quantity demanded (positive elasticity).
      • Inferior goods: Increase in income leads to a decrease in quantity demanded (negative elasticity).
    • Cross-price elasticity of demand measures how quantity demanded of one good changes with a change in the price of another good.
      • Substitutes: Increase in the price of one good leads to an increase in the demand for the other (positive elasticity).
      • Complements: Increase in the price of one good leads to a decrease in the demand for the other (negative elasticity).

    The Elasticity of Supply

    • Price elasticity of supply measures how quantity supplied changes in response to price changes.
    • Elastic supply: Quantity supplied responds substantially to price changes.
    • Inelastic supply: Quantity supplied responds minimally to price changes.
    • Time horizon significantly impacts supply elasticity (more elastic in the long run).
    • Supply elasticity is calculated as the percentage change in quantity supplied divided by the percentage change in price.

    The Variety of Supply Curves

    • Supply curves are categorized by their elasticity.
    • Perfectly inelastic supply: Quantity supplied is constant regardless of price.
    • Inelastic supply: Quantity supplied changes less than proportionately to price changes.
    • Unit elastic supply: Quantity supplied changes proportionately to price changes.
    • Elastic supply: Quantity supplied changes more than proportionately to price changes.
    • Perfectly elastic supply: Any price change leads to 0 or infinite quantity supplied.

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    Description

    Understand price elasticity of demand, which measures how quantity demanded responds to price changes. Explore factors like substitutes, necessities, and time horizon. Learn the midpoint method for accurate elasticity calculation.

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