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Elasticities of Demand and Supply 5 CHECKPOINTS

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© 2013 Pearson Practice Problem 1 When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. Is the demand for this good elastic, unit elastic, or inelastic? CHECKPOINT 5.1

© 2013 Pearson Solution The demand for a good is inelastic if the percentage decrease in the quantity demanded is less than the percentage increase in its price. In this example, a 10 percent price rise brings a 2 percent decrease in the quantity demanded, so demand is inelastic. CHECKPOINT 5.1

© 2013 Pearson Study Plan Problem When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. Demand for this good is __________. CHECKPOINT 5.1 A.Inelastic B.Elastic C.unit elastic

© 2013 Pearson Practice Problem 2 When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. Are substitutes for this good easy to find or does it have poor substitutes? Is this good more likely to be a necessity or a luxury? Why? Is the good more likely to be narrowly or broadly defined? Why? CHECKPOINT 5.1

© 2013 Pearson Solution Because the good has an inelastic demand, it most likely has poor substitutes. is a necessity rather than a luxury. is broadly defined. CHECKPOINT 5.1

© 2013 Pearson Study Plan Problem When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. Most likely, this good ___________ and ____________. CHECKPOINT 5.1 A.has poor substitutes; is a luxury B.is a necessity; has poor substitutes C.is a luxury; is narrowly defined D.is a necessity; has good substitutes E.is broadly defined; is a luxury

© 2013 Pearson Practice Problem 3 When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. Calculate the price elasticity of demand for this good. Explain how the total revenue from the sale of the good has changed. Explain which of the following goods this good is most likely to be: orange juice, bread, toothpaste, theater tickets, clothing, blue jeans, Super Bowl tickets. CHECKPOINT 5.1

© 2013 Pearson Solution Price elasticity of demand = Percentage change in the quantity demanded ÷ Percentage change in price. Price elasticity of demand = 2 ÷ 10 or 0.2. An elasticity less than 1 means that demand is inelastic. When demand is inelastic, a price rise increases total revenue. This good is most likely a necessity (bread), or has poor substitutes (toothpaste), or is broadly defined (clothing). CHECKPOINT 5.1

© 2013 Pearson Study Plan Problem When the price of a good increased by 10 percent, the quantity demanded of it decreased 2 percent. The price elasticity of demand is ___. A price rise will ____ total revenue. ____ is a good with such a demand. CHECKPOINT 5.1 A.5.0; decrease; Toothpaste B.0.2; increase; Toothpaste C.0.2; decrease; Super Bowl tickets D.5.0; decrease; Blue jeans E.5.0; increase; Super Bowl tickets

© 2013 Pearson In the News Music giant chops price to combat downloads In 2003, when music downloading first took off, Universal Music slashed the price of a CD from $21 to $15. The company said that it expected the price cut to boost the quantity of CDs sold by 30 percent, other things remaining the same. Source: Globe and Mail, September 4, 2003 What was Universal Music’s estimate of the price elasticity of demand for CDs? Was demand estimated to be elastic or inelastic? CHECKPOINT 5.1

© 2013 Pearson Solution Price elasticity of demand = Percentage change in the quantity demanded ÷ Percentage change in price. The Percentage change in the price equals [($21 – $15)/($18)] × 100, which is 33.3 percent. The Percentage change in the quantity is 30 percent. So the estimated price elasticity of demand is 30 percent ÷ 33.3 percent, or 0.9. An estimated elasticity of 0.9 means that demand is estimated to be inelastic. CHECKPOINT 5.1

© 2013 Pearson Practice Problem 1 You are told that a 10 percent increase in the price of a good has led to a 1 percent increase in the quantity supplied of the good after one month and a 25 percent increase in the quantity supplied after one year. Is the supply of this good elastic, unit elastic, or inelastic? Is this good likely to be produced using factors of production that are easily obtained? What is the price elasticity of supply of this good? CHECKPOINT 5.2

© 2013 Pearson Solution The supply of a good is inelastic if the percentage increase in the quantity supplied is less than the percentage increase in price. In this example, a 10 percent price rise brings a 1 percent increase in the quantity supplied, so supply is inelastic. CHECKPOINT 5.2

© 2013 Pearson Because the quantity supplied increases by such a small percentage after one month, the factors of production that are used to produce this good are more likely to be difficult to obtain. The elasticity of supply equals the percentage change in the quantity supplied divided by the percentage change in the price. Elasticity of supply = 1 ÷ 10 or 0.1. CHECKPOINT 5.2

© 2013 Pearson Study Plan Problem You are told that a 10 percent increase in the price of a good has led to a 1 percent increase in the quantity supplied of that good after one month. Supply of the good is ____. CHECKPOINT 5.2 A.inelastic B.unit elastic C.elastic D.decreasing E.increasing

© 2013 Pearson Practice Problem 2 You are told that a 10 percent increase in the price of a good has led to a 1 percent increase in the quantity supplied of the good after one month and a 25 percent increase in the quantity supplied after one year. What is the elasticity of supply of this good after one year? Has the supply of this good become more elastic or less elastic? Why? CHECKPOINT 5.2

© 2013 Pearson Solution 1.Elasticity of supply = Percentage change in the quantity supplied ÷ Percentage change in the price. 2.After one year, the elasticity of supply = 25 ÷ 10 = The supply of the good has become more elastic over the year since the price rise. 4.Possibly other producers have gradually started producing the good and with the passage of time more factors of production can be reallocated. CHECKPOINT 5.2

© 2013 Pearson In the News Weak coal prices hit China's third-largest coal miner The chairman of Yanzhou Coal Mining, Wang Xin, reported that the global financial crisis has decreased the demand for coal, with its sales falling by 11.9 percent to 7.92 million tons from 8.99 million tons a year earlier, despite the price falling by 10.6 percent. Source: Dow Jones, April 27, 2009 Calculate the price elasticity of supply of coal at Yanzhou Coal Mining. Is its supply of coal elastic or inelastic? CHECKPOINT 5.2

© 2013 Pearson Solution Elasticity of supply = Percentage change in the quantity supplied ÷ Percentage change in the price. Yanzhou Coal Mining’s price elasticity of supply equals 11.9 percent divided by 10.6 percent, or The quantity supplied fell by a larger percentage than the price, so supply of coal is elastic. That is what an elasticity of supply of 1.12 means. CHECKPOINT 5.2

© 2013 Pearson Practice Problem 1 The quantity demanded of good A increases by 5 percent when the price of good B rises by 10 percent and other things remain the same. Are goods A and B complements or substitutes? Describe how the demand for good A changes. Calculate the cross elasticity of demand. CHECKPOINT 5.3

© 2013 Pearson Solution Goods A and B are substitutes because when the price of good B rises, the quantity demanded of good A increases. As the price of good B rises, people switch from good B to good A. The demand for good A increases. CHECKPOINT 5.3

© 2013 Pearson Cross elasticity of demand = Percentage change in the quantity demanded of good A ÷ Percentage increase in the price of good B. Cross elasticity of demand = 5 ÷ 10 or 0.5. CHECKPOINT 5.3

© 2013 Pearson Practice Problem 2 When income rises by 5 percent and other things remain the same, the quantity demanded of good C increases by 1 percent. Is good C a normal good or an inferior good? Describe how the demand for good C changes. Calculate the income elasticity of demand for good C. CHECKPOINT 5.3

© 2013 Pearson Solution Because the quantity demanded of good C increases when income increases, good C is a normal good. An increase in income increases the demand for good C. CHECKPOINT 5.3

© 2013 Pearson Income elasticity of demand = Percentage change in the quantity demanded of good C ÷ Percentage increase in income. Income elasticity of demand = 1 ÷ 5 or 0.2. CHECKPOINT 5.3

© 2013 Pearson In the News Rising incomes make China the world’s largest luxury goods market China is estimated to become the world’s largest luxury goods market over the next decade, boosted by rising incomes and a transition from saving to spending culture. Source: ibtimes, February 2, 2011 Are luxury goods normal goods or just not necessities? Explain your answer. CHECKPOINT 5.3

© 2013 Pearson Solution To know whether a good is a normal good we need to calculate the income elasticity of demand. A normal good is a good that has a positive income elasticity of demand. The source of the increase in the quantity of luxury good bought is rising incomes and people spending past savings. So the income elasticity of demand is positive. Luxury good are normal goods. CHECKPOINT 5.3