Using the midpoint method, calculate the price elasticity of demand if the price of a good rises from \10 to \15 and the quantity demanded falls from 100 units to 60 units.
Remember to divide the change in each variable by the average of the starting and ending values.
This results from using a simple percentage change calculation based on the starting values rather than the averages required by the midpoint method.
The midpoint method calculates the percentage change in quantity as 40/80 = 50% and the percentage change in price as 5/12.5 = 40%, yielding 50/40 = 1.25.
This value represents the inverse of the elasticity, potentially calculated by dividing the percentage change in price by the percentage change in quantity demanded.
This might be obtained by using the end-point values as the base for percentage changes rather than the midpoints.
Question 2/ 10
If the demand for a specific good is elastic, how will a 5% decrease in the price of that good affect the total revenue?
Consider whether the quantity purchased will rise more or less proportionately than the price drop.
This outcome would occur if demand were inelastic, meaning the percentage gain in quantity would not offset the percentage loss in price.
When demand is elastic, the percentage increase in quantity demanded is greater than the percentage decrease in price, leading to a net gain in total revenue.
This would only happen if the price elasticity of demand were exactly one, known as unit elasticity.
Total revenue is determined entirely by the price and the quantity demanded along the demand curve; supply determines the equilibrium but not the definition of revenue.
Question 3/ 10
Why does the price elasticity of demand vary along a linear demand curve despite the slope remaining constant?
Think about how a one-unit change in quantity compares to a small starting quantity versus a large starting quantity.
The slope is actually the ratio of absolute changes in the variables, whereas elasticity is the ratio of percentage changes.
Elasticity depends on the percentage changes; at the top of the curve where quantity is low, even a small unit change is a large percentage of the total.
Only specific non-linear demand curves maintain constant elasticity; linear curves transition from elastic to inelastic.
The midpoint method is a valid tool for calculating elasticity between any two points on a linear or non-linear curve.
Question 4/ 10
If the cross-price elasticity of demand between good X and good Y is -1.2, what can be inferred about the relationship between these two goods?
The negative sign indicates that the price of one good and the demand for the other move in opposite directions.
Substitutes have a positive cross-price elasticity because an increase in the price of one leads to an increase in the demand for the other.
A negative cross-price elasticity indicates complements, and a value with an absolute magnitude greater than one suggests a significant response.
Inferior and normal goods are determined by income elasticity of demand, not cross-price elasticity.
Cross-price elasticity measures the response of one good to the price of a *different* good, not its own price responsiveness.
Question 5/ 10
According to the analysis of the oil market, why did the OPEC cartel find it difficult to maintain high oil prices in the long run compared to the short run?
Think about how the ability of consumers to switch to fuel-efficient cars changes over several years.
This statement is the opposite of reality; short-run curves are inelastic because consumers and producers cannot adjust quickly.
Over time, consumers find more fuel-efficient alternatives and producers develop more extraction sites, making quantity more responsive to price changes.
Total revenue increases when supply shifts left if demand is inelastic, which is typically the case in the short-run oil market.
While true in a historical sense, the economic explanation focused on here is the change in the elasticity of market participants over time.
Question 6/ 10
In the context of the 'war on drugs,' what is the likely impact of successful drug interdiction on the total amount spent by drug users, assuming the demand for drugs is inelastic?
Consider how an addict's necessity for a substance affects their responsiveness to price increases.
Although quantity falls, if demand is inelastic, the percentage increase in price exceeds the percentage decrease in quantity, raising total expenditures.
Drug interdiction reduces supply, and with inelastic demand, this leads to a significantly higher price that more than compensates for the smaller quantity sold.
A fixed budget would imply unit elasticity, but the text suggests drug demand is typically inelastic due to addiction.
Interdiction is a supply-side policy; demand-side policies like education have different effects on total spending and price.
Question 7/ 10
Which of the following scenarios best explains why 'good news' for farming (such as a new high-yield hybrid wheat) can be 'bad news' for farmers?
Focus on the relationship between the percentage change in price and the percentage change in the consumption of basic food items.
An increase in supply leads to a *decrease* in price, which increases the quantity demanded but might lower total revenue.
Because the demand for wheat is inelastic, the lower price resulting from higher supply causes a less-than-proportionate increase in quantity sold, reducing total revenue for farmers.
Supply elasticity measures responsiveness to price, not the ability to adopt technology; adopting technology is what shifts the supply curve.
Agricultural technology improvements shift the *supply* curve to the right, not the demand curve.
Question 8/ 10
A firm's price elasticity of supply is often higher at low levels of quantity supplied because:
Think about the availability of 'room to grow' within a factory's current setup.
Maximum capacity leads to a very *inelastic* supply because the firm cannot increase output regardless of price increases.
When production levels are low, firms often have underutilized equipment and labor that can be quickly activated when prices improve.
Input prices generally rise or stay the same as production increases; elasticity here is about the technical ease of increasing output.
Supply is generally more inelastic in the short run because firms have limited time to adjust their scale of production.
Question 9/ 10
If the income elasticity of demand for a good is -0.5, how will a 10% increase in consumer income affect the market for that good?
Determine if the good is 'normal' or 'inferior' based on the sign of the elasticity value.
A positive increase in quantity would happen if the income elasticity were positive (a normal good).
A negative income elasticity indicates an inferior good; therefore, an increase in income leads to a decrease in quantity demanded (10% × -0.5 = -5%).
Income elasticity measures the shift in the demand curve (quantity demanded at a given price), not a move along the curve due to a price change.
Luxury goods have an income elasticity greater than one; a negative value defines the good as inferior.
Question 10/ 10
How does the 'time horizon' determinant affect the price elasticity of demand for gasoline?
Consider the difference between a consumer's options tomorrow versus their options three years from now.
Most people cannot change their habits or vehicle choices instantly, making short-run demand relatively inelastic.
Over longer periods, consumers have more flexibility to make significant lifestyle and purchase changes that reduce their dependency on the good.
Even for necessities, the degree of responsiveness increases as more alternatives and adjustments become possible over time.
While substitutes are limited, the demand is not perfectly inelastic; people still adjust their behavior in response to price changes.