ECO 284 - Microeconomics - Dr. D. Foster Elasticity Problems ECO 284 - Microeconomics - Dr. D. Foster

Elasticity Problems εD = 10%/50% = .20 1. If the price of butter goes up 50% and the quantity demanded falls by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? εD = 10%/50% = .20 This is inelastic (< 1.0) … It is likely to be a small portion of our budgets.

Elasticity Problems εD = 10%/[$2/$20] = 10%/10% = 1.0 2. If the price of the Rolling Stones’ CD, Semi-Serious, is reduced from $20 to $18, and the quantity demanded (say, on a per month basis) rises by 10%, what is the price elasticity of demand? Is this elastic or inelastic? Why? εD = 10%/[$2/$20] = 10%/10% = 1.0 This is “unit elastic” (= 1.0) … It doesn’t easily fit into any categories insofar as elastic vs. inelastic goes.

Elasticity Problems εD = [100,000/1,000,000]/30% = 10%/30% = .33 3. If the price of gas goes up by 30% and the quantity demanded falls from 1,000,000 gallons/day to 900,000 gallons/day, what is the price elasticity of demand? Is this elastic or inelastic? Why? εD = [100,000/1,000,000]/30% = 10%/30% = .33 This is inelastic (< 1.0) … It is likely to be considered a necessity.

Elasticity Problems 3. (con’t) If the price, then, falls back by 30%, would you predict the response by consumers will be elastic or inelastic? Why? It would still be inelastic… Consumers will buy more when the price falls. (that is just the law of demand at work) But, they will not buy a lot more.

Elasticity Problems εD = [10,000/10,000]/[$40/$80] = 100%/50% = 2.0 4. A popular pair of Nike shoes, the Paris Hilton Liteweights, is reduced in price from $80 to $40, while the quantity demanded rises from 10,000 pairs/week to 20,000 pairs/week. What is the price elasticity of demand? Is this elastic or inelastic? Why? εD = [10,000/10,000]/[$40/$80] = 100%/50% = 2.0 This is elastic (> 1.0) … It is likely that there are many substitutes available.

Elasticity Problems 5. What do execs at Pepsi expect TR to do when they have a sale on their soft drink? Why? Expect revenues to rise!!! Demand is elastic . . . lots of substitutes. 6. You manage a concert hall that seats 500. Consider the following demand information. What do you charge? A price of $15 will max. revenue. At a price of: Amount sold is: $10 500 $15 400 $20 200

Elasticity Tax Problem price DA DB quantity $1.40 $1.10 $1.00 $.90 $.60 100 80 50 For the accompanying graph, assume that equilibrium starts at point A. Consider the effects of a tax, which will decrease the supply, for two alternative demand curves, DA and DB. Yes, supply “decreases” and shifts up by $.50 (see q=80). a. A $.50 per unit tax is placed on this good – does S’ show the new supply curve?

Elasticity Tax Problem price DA DB quantity $1.40 $1.10 $1.00 $.90 $.60 100 80 50 For the accompanying graph, assume that equilibrium starts at point A. Consider the effects of a tax, which will decrease the supply, for two alternative demand curves, DA and DB. $112 $55 $100 b. What is the change in total revenue along DA and DB? DA - From $100 to $55; total revenue fell by $45. DB - From $100 to $112; total revenue rose by $12.

Elasticity Tax Problem price DA DB quantity $1.40 $1.10 $1.00 $.90 $.60 100 80 50 For the accompanying graph, assume that equilibrium starts at point A. Consider the effects of a tax, which will decrease the supply, for two alternative demand curves, DA and DB. c. What does this tell you about the price elasticity for each demand curve? DA is elastic (P - TR) while DB is inelastic (P - TR).

D for DA is (50/100)/(.1/1) = 50%/10% = 5.0 Elasticity Tax Problem S’ S A price DA DB quantity $1.40 $1.10 $1.00 $.90 $.60 100 80 50 For the accompanying graph, assume that equilibrium starts at point A. Consider the effects of a tax, which will decrease the supply, for two alternative demand curves, DA and DB. As an additional exercise, we can calculate the price elasticity for each demand curve: D for DA is (50/100)/(.1/1) = 50%/10% = 5.0 D for DB is (20/100)/(.4/1) = 20%/40% = 0.5

Elasticity Tax Problem price DA DB quantity $1.40 $1.10 $1.00 $.90 $.60 100 80 50 For the accompanying graph, assume that equilibrium starts at point A. Consider the effects of a tax, which will decrease the supply, for two alternative demand curves, DA and DB. $40 $25 d. What will be the tax revenue collected in each case? DA - Tax revenue = ($.50)*50 units = $25. DB - Tax revenue = ($.50)*80 units = $40.

ECO 284 - Microeconomics - Dr. D. Foster Elasticity Problems ECO 284 - Microeconomics - Dr. D. Foster