Week 4 Elasticity Seminar Guide PDF

Elasticity – Seminar Guide 11. Suppose the price elasticity of demand for petrol is estimated to be -0.1 and the income elasticity is estimated to be +1.2 State whether the following statements are true or false:- a) a tax on petrol will not have much effect on con...

Elasticity – Seminar Guide 11. Suppose the price elasticity of demand for petrol is estimated to be -0.1 and the income elasticity is estimated to be +1.2 State whether the following statements are true or false:- a) a tax on petrol will not have much effect on consumption true b) a tax on petrol will raise lots of revenue because demand is inelastic true c) a rise in incomes of 10% will lead to an increase in the amount of petrol bought of more than 10 percent. true d) the price and quality of public transport, and the presence or absence of cycleways, will affect the elasticity of demand for petrol true Reasoning:  Petrol’s inelastic demand means that a price increase won’t drastically reduce consumption, but will generate revenue.  Petrol has a positive income elasticity, so as income rises, so does petrol demand.  Availability and quality of transport alternatives influence petrol demand elasticity. Cross-price elasticity of demand 12. State whether you would expect the cross-price elasticity of demand between the following goods to be positive, negative or zero, and explain why. a) margarine and butter b) petrol and motor vehicles c) coffee and cocoa d) motor cycles and motor cycle helmets e) CD players and CDs f) coal and gas g) holidays in Ireland and holidays in Scotland Answers:  a) Margarine and butter: Substitutes (positive XED)  b) Petrol and motor vehicles: Complements (negative XED)  c) Coffee and cocoa: Substitutes (positive XED)  d) Motorcycles and helmets: Complements (negative XED)  e) CD players and CDs: Complements (negative XED)  f) Coal and gas: Substitutes (positive XED) 1  Elasticity – Seminar Guide  g) Holidays in Ireland and holidays in Scotland: Substitutes (positive XED) Reasoning: Substitute goods have a positive XED because an increase in the price of one increases demand for the other. Complementary goods have a negative XED because an increase in the price of one reduces demand for the other. 13. Assume the cross-price elasticity of demand for white grapes with respect to black grapes is +2. If the price of black grapes falls by 8% what will happen to the demand for white grapes? Answer: Demand for white grapes decreases by 16%. Reasoning: As black grapes become cheaper, consumers buy fewer white grapes, shifting their demand to black grapes. Elasticity of Supply The elasticity of supply is defined as:- percentage increase in quantity supplied percentage increase in price 14. The following table shows the output of an agricultural commodity over a ten year period together with the price output price (£/tonne) 1980 100 16 1990 300 32 Based on this data work out the coefficient for the elasticity of supply. Which of the following statements are true: a) The supply of this commodity seems to be inelastic. False b) The percentage increase in output is more than the percentage increase in price. Therefore supply is said to be elastic. True c) We would expect supply to be elastic since it is easier for farmers to switch from growing one crop to another than it is for industry to switch from producing one 2  Elasticity – Seminar Guide manufactured product to another. True %∆Q= +200% %∆P= =100% PES = %∆Q/%∆P PES = 200/100 PED=+2 Answer: PES is 2, indicating elastic supply. Reasoning: Since the percentage change in quantity supplied is greater than the percentage change in price, supply is elastic, meaning producers can respond quickly to price changes. 3