Introduction To Economics Tutorial 4 PDF

INTRODUCTION TO Economics (ECON101) Tutorial 4 1  Elasticity Elasticity:A measure of the responsiveness of quantity demanded or quantity supplied to one of its Determinants. Price Elasticity of Demand: A measure of how much the quantity demanded of a go...

INTRODUCTION TO Economics (ECON101) Tutorial 4 1  Elasticity Elasticity:A measure of the responsiveness of quantity demanded or quantity supplied to one of its Determinants. Price Elasticity of Demand: A measure of how much the quantity demanded of a good responds to a change in the price of that good As Price increase, quantity demanded decrease But by how much?  Both are demand curves as P Q P P 3 3 2 2 D D Q Q 4 6 4 5 P Q P Q  Determinants of elasticity of demand 1. Availability of close substitutes Goods with close substitutes – more elastic demand 2. Degree of Necessity 3. Definition of the market Narrowly defined markets – more elastic demand 4. Time horizon Demand is more elastic over longer time horizons 5. Proportion of income spent Goods like newspaper may be price inelastic in demand  TYPES OF DEMAND Perfectly Inelastic Inelastic Unit Elastic Elastic Perfectly Elastic PED = 0 PED < 1 PED = 1 PED > 1 PED = ∞ P P P P Do P Do Do P2 Do P2 P2 P2 Do P1 P1 P1 P1 P1 Q2 Q1 Q2 Q1 Q2 Q1 constant Q Q Q Q Q1 Q2 Q Whatever is the change in price, If P > P1, Qd=0 ΔP > ΔQ ΔP = ΔQ ΔP < ΔQ Qd doesn’t If P < P1, Qd=∞ change. No response Weak response Proportionate Strong response Infinite response to price changes to price change response to to price change to price change price change  Elasticity Elasticity:A measure of the responsiveness of quantity demanded or quantity supplied to one of its Determinants. Price Elasticity of Supply: A measure of how much the quantity supplied of a good responds to a change in the price of that good As Price increase, quantity supplied increase But by how much?  Both are supply curves as P Q P P 3 3 2 2 Q Q 4 6 4 5 P Q P Q  Determinants of elasticity of supply 1. Time Horizon Supply is more elastic in long run 2. Availability of resources Which good is flexible to expand production at low costs?  TYPES OF SUPPLY Perfectly Inelastic Unit Elastic Elastic Perfectly Elastic Inelastic PES = 0 PES < 1 PES = 1 PES > 1 PES = ∞ P P So P So P P So So P2 P2 So P2 P2 P1 P1 P1 P1 P1 constant Q1 Q2 Q1 Q2 Q1 Q2 Q1 Q2 Q Q Q Q Q Whatever is the change in price, If P > P1, Qs=∞ ΔP > ΔQ ΔP = ΔQ ΔP < ΔQ Qs doesn’t If P < P1, Qs=0 change. No response to Weak response Proportionate Strong response Infinite response price changes to price change response to to price change to price change price change  ✘ Ways to calculate PED or PES 1. % Change Method: %∆𝑸 𝒏𝒆𝒘 𝑸 − 𝒐𝒍𝒅 𝑸 𝒏𝒆𝒘 𝑷 − 𝒐𝒍𝒅 𝑷 PED or PES = = × 𝟏𝟎𝟎 ÷ × 𝟏𝟎𝟎 %∆𝑷 𝒐𝒍𝒅 𝑸 𝒐𝒍𝒅 𝑷 2. Mid-Point Method: 𝑸𝟐 − 𝑸𝟏 𝑷𝟐 − 𝑷𝟏 PED or PES = ÷ 𝑸𝟐 + 𝑸𝟏 ÷ 𝟐 𝑷𝟐 + 𝑷𝟏 ÷ 𝟐 Elasticity & Maximizing Total Revenue TR= P*Q ✘ Inelastic Demand Vs. Elastic Demand If demand is inelastic, If demand is elastic, increase price to increase TR Decrease price to increase TR Sheet 4 12 Q1: A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain. ✘ When the price increases and the quantity demanded decreases, yet total revenue rises, this indicates that the demand curve is inelastic 13 Q2: For each of the following pairs of goods, which good would you expect to have more elastic demand and why? a. Required textbooks or mystery novels Mystery novels would have more elastic demand than required textbooks. Required textbooks are considered necessities for students, as they are essential for completing coursework. Even if the price of textbooks increases, students are likely to still purchase them, making the demand relatively inelastic. Mystery novels are a form of entertainment with many substitutes (other types of novels, movies, podcasts, etc.). If the price of mystery novels increases, consumers can easily switch to other forms of entertainment, making the demand more elastic. Q2: For each of the following pairs of goods, which good would you expect to have more elastic demand and why? b. Beethoven recordings or classical music recordings in general  Beethoven recordings would have more elastic demand than classical music recordings in general. Beethoven recordings represent a narrower category within classical music. If the price of Beethoven recordings increases, consumers can easily substitute with other classical composers (Mozart, Bach, etc.), making the demand for Beethoven recordings more elastic.  Classical music recordings as a whole cover a broader range of music, so the availability of substitutes is lower when considering classical music in general. Therefore, the demand for classical music recordings as a whole is likely to be more inelastic compared to a specific composer like Beethoven. Q3: Suppose the price of wheat increases from $4.00 to $5.00 per bushel, and as a result, the quantity of wheat supplied increases from 1,200 bushels to 1,500 bushels. Calculate the Price Elasticity of Supply using the midpoint method, and interpret whether the supply of wheat is elastic, inelastic, or unit elastic. 𝑄2 −𝑄1 𝑄2 +𝑄1 2 PES = 𝑃2 −𝑃1 𝑃2 +𝑃1 2 1500−1200 1500+1200 PES = 2 5−4 =1 Unit Elastic 5+4 2 Q4: Consider the given data and then answer the below questions Qd: Qd: P Business Vacationers Travelers $150 2100 1000 200 2000 800 250 1900 600 300 1800 400 a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travellers and (ii) vacationers? (Use the midpoint method in your calculations). b. Why might vacationers have a different elasticity from business travellers?  Q4: Consider the given data and then answer the below questions Qd: Qd: a. As the price of tickets rises from $200 to $250, what is the price elasticity P Business Vacationers of demand for (i) business travellers and (ii) vacationers? (Use the Travelers midpoint method in your calculations). $150 2100 1000 200 2000 800 𝑄2 −𝑄1 250 1900 600 𝑄2 +𝑄1 2 300 1800 400 Midpoint Method = PED = 𝑃2 −𝑃1 𝑃2 +𝑃1 2 (i) Business Travellers (ii) Vacationers 600−800 1900−2000 600+800 1900+2000 PED = 2 250−200 = −0.23 PED = 2 250−200 = −1.29 250+200 250+200 2 2 Inelastic Elastic Q4: Consider the given data and then answer the below questions b. Why might vacationers have a different elasticity from business travellers?  Business travellers often travel for work purposes, making their travel a necessity. This results in inelastic demand, as they must travel even if prices increase Vacationers, on the other hand, travel for leisure, which is a luxury. If ticket prices rise, vacationers can delay or cancel their travel plans, making their demand more elastic.  Vacationers have many substitutes, such as opting for a closer destination, choosing alternative transportation, or postponing their vacation. Business travellers often have fewer substitutes, especially if meetings or conferences must be attended in person.  Business travellers may have less flexibility in timing, as their trips are often tied to specific work events or meetings. Vacationers can adjust their travel plans to take advantage of lower prices at other times, contributing to their higher elasticity.  Vacationers are typically more price-sensitive, Higher prices might cause them to forgo travel entirely, leading to more elastic demand. Business travelers might be less sensitive to price changes, especially if travel is covered by their employers. Q5: You are the curator of a museum. The museum is running short of funds, so you decide to increase revenue. Should you increase or decrease the price of admission? Explain o If demand is inelastic, total revenue increases when price increases (because the decrease in quantity demanded is proportionally smaller than the increase in price). o If demand is elastic, If total revenue decreases when price increases (because the decrease in quantity demanded is proportionally larger than the increase in price). Respectively, it is recommended to divide the market into segments based on elasticity.  Divide between adults, children and senior: It is expected that adults and seniors are more elastic thus pay less price  Divide between foreigners and citizens, citizens are more elastic – foreigners are most probably tourists that are coming to visit the museum regardless – so set less price to citizens  Divide between students and non-students: students usually have lower budget so charge less price to students as tickets represents higher cost to their income  Q6: The price of coffee rose sharply last month, while the quantity sold remained the same. Three people suggest various explanations:  Leonard: Demand increased, but supply was perfectly inelastic. P S Price increased Quantity remained the same True justification D2 D1 Q  Q6: The price of coffee rose sharply last month, while the quantity sold remained the same. Three people suggest various explanations:  Sheldon: Demand increased, but it was perfectly inelastic. D1 D2 S P Price increased Quantity Increased False justification Q  Q6: The price of coffee rose sharply last month, while the quantity sold remained the same. Three people suggest various explanations:  Raj: Supply decreased, but demand was perfectly inelastic. S2 D S1 P Price increased Quantity remained the same True justification Q  Other Important Elasticities Other Important Elasticities Inferior Goods: Negative Income Elasticity Normal Goods: Positive Income Elasticity Necessities: Smaller Income Elasticity (less than 1) Luxuries goods: Larger Income Elasticities (more than 1)  Other Important Elasticities Other Important Elasticities Substitute goods: Positive Complementary goods: negative Q7: Short answer questions: 1- If the income elasticity of demand for a GOLF car is 2.5, what does this imply about the demand for GOLF cars as consumer incomes increase? This suggests that GOLF cars are a normal luxury good, as the elasticity is positive and greater than 1. A 1% increase in consumer income would lead to a 2.5% increase in the quantity demanded for GOLF cars. Q7: Short answer questions: 2- If the price of printer ink increases by 20% and, as a result, the quantity demanded for printers decreases by 10%, calculate the cross-price elasticity of demand between printer ink and printers. Interpret your findings. −10%  Cross-price elasticity = = −0.5 20%  A cross-price elasticity of −0.5-0.5−0.5 indicates that printer ink and printers are complementary goods. This means that as the price of printer ink increases, the quantity demanded for printers decreases, but not very strongly. The negative sign shows the inverse relationship typical of complementary goods: when one becomes more expensive, the demand for the other tends to decline. ✘ Thank you! ✘Case 1 28