TUTORIAL EXERCISES

Question 1
Suppose a hurricane decreased the supply of oranges so that the price of oranges rose from $120 a ton
to $180 a ton and quantity sold decreased from 800 tons to 240 tons. What is the absolute value of the
price elasticity of demand? Use the mid-point formula.

(Q 2−Q 1) ( P 2−P 1)
Price elasticity of demand= ÷
Q 1+Q 2 P 1+ P 2
( ) ( )
2 2

P1 = $120; P2 = $180; Q1 = 800 tons; Q2 = 240 tons

(240−800) ( $ 180−$ 120)

Price elasticity of demand= ÷
800+240 $ 120+ $ 180
( ) ( )
2 2

Price elasticity of demand=−1.0769/0.4=−2.69225=2.69225

Question 2
What are the key determinants of the price elasticity of demand for a product? Explain and provide
specific example of each. Which determinant is the most important?

i. The availability of close substitutes to the goods (The most important determinants of price
elasticity of demand)

A consumer’s reaction to a change in the price of a product depends on whether there are other
alternative products. If a product has more substitutes available, it will have a more elastic demand (E.g.:
When the price of gasoline rises, consumers have few alternatives, so the quantity demanded falls only
a little). If a product has fewer substitutes available, it will have a less elastic demand (E.g.: When the
price of pizza rises, consumers have many alternative foods they can choose, so the quantity demanded
is likely to fall substantially.

ii. The passage of time

Consumers take some time to adjust their buying habits when prices change. The more time that passes,
elastic the demand for a product becomes, meanwhile, the less time that passes, inelastic the demand
for a product becomes.

iii. Whether the good is a luxury or a necessity

Luxury goods are normally more elastic than necessary goods. The demand curve for a luxury is more
elastic than the demand curve for a necessity (The demand for ticket to a concert is elastic as it is a
luxury, the quantity that people buy is strongly dependent on its price). The demand curve for a
necessity is more inelastic than the demand curve for a luxury (The demand for bread is inelastic as it is
a necessity, the quantity that people buy is not very dependent on its price)
 iv. The definition of the market

The more narrowly we define a market, the more elastic demand will be; The more widely we define a
market, the more inelastic demand will be. This is because in a narrowly defined market, consumers
have more substitutes available; In a widely defined market, consumers have few substitutes available.

v. The share of the good in the consumer’s budget.

Good that take only a small fraction of a consumer’s budget tent to have less elastic demand than goods
that take a large fraction. The demand for a good will be more elastic the larger the share of the good in
the average consumer’s budget (Increases in the prices of necessity: salt and sugar, are likely to result in
only a small decline in the quantity demanded). The demand for a good will be more inelastic the
smaller the share of the good in the average consumer’s budget (Increases in the prices of big-ticket
items: houses, cars, and furniture, are likely to result in significant declines in the quantity demanded)

Question 3
Use the following graph for Yolanda’s Frozen Yogurt Stand to answer the questions

Price ($ per day) D2

A
$3.00
B C
2.50

D1

200 225 300 Quantity (cones per day)

a. Use the midpoint formula to calculate the price elasticity of demand for D1 between point A and
point C and the price elasticity of demand for D2 between point A and point B. Which demand
curve is more elastic? Briefly explain

P1: 3.00; Q1: 200; P2: 2.50; Q2: 300

(300−200) (2.5−3)
Price elasticity of demand( A∧C)= ÷ =0.4 /−0.1818=2.200
200+ 300 3+2.5
( ) ( )
2 2

P1: 3.00; Q1: 200; P2: 2.50; Q2: 225

(300−225) ( 2.5−3)
Price elasticity of demand( A∧B)= ÷ =0.2857 /−0.1818=1.5715
225+300 3+2.5
( ) ( )
2 2
Coefficient = 2.2 = Responsive to the change of price

Along D1, cutting the price from $3.00 to $2.50 increases the quantity demanded from 200
units to 300 units per day. Because the percentage change in quantity demanded is greater
than the percentage change in price (in absolute value), demand is elastic between point A and
point C.

Along D2, cutting the price from $3.00 to $2.50 increases the quantity demanded only from 200
to 225 units per day only. Because the percentage change in quantity demanded is smaller than
the percentage change in price (in absolute value), demand is inelastic between point A and
point B.

**PLS ADD ON MORE EXPLANATION AND EXAMPLES

b. Suppose Yolanda is initially selling 200 cones per day at a price of $3.00 per cone. If she cuts the
price to $2.50 per cone and her demand curve is D1, what will be the change in her revenue?
What will be the change in her revenue if her demand curve is D2?
Total revenue = Price x Quantity

From Point A to C, total revenue increase. The decrease in price can generates enough extra customers
to more than offset revenue lost. Along D1, total revenue increase from 600 to 750. This is because

From Point A to B, total revenue decrease. Revenue decrease because the curve is inelastic when the
firm decrease the price

Question 4
Are the cross elasticities of demand between the following pairs of products likely to be positive or
negative? Explain.
a. Iced coffee and iced tea

Positive, iced coffee and iced tea are substitutes

b. French fries and ketchup

Negative, French fries and ketchup are complements

c. Steak and chicken

Positive, steak and chicken are substitutes

d. Blu-ray players and Blu-ray discs

Negative, Blu-ray players and Blu-ray discs are complements

The cross-price elasticity of demand is positive or negative depending on whether the two products are
substitutes or complements or unrelated products. Substitutes are products that can be used for the
same purpose, which means an increase in the price of a substitute will lead to an increase in the
quantity demanded, thus, the cross-price elasticity will be positive. Complements are products that are
used together, which means that an increase in the price of a complement will lead to a decrease in the
quantity demanded, thus, the cross-price elasticity of demand will be negative. **If the two products
are unrelated, the cross-price elasticity of demand will be zero.

Question 5
Describe the relationship between price elasticity of demand and total revenue when price changes.

Media Review Analysis

Why Dairy Demand Has Become More Elastic

You may have learned in your high-school or college economics class that dairy consumption is relatively
“inelastic,” meaning that demand for food staples like milk, butter and cheese varies little with price.

But times have changed, and dairy demand is not inelastic as it once was, says Sara Dorland, managing
partner with Seattle-based Ceres Dairy Risk Management. Higher prices can have a direct effect on
consumption of dairy products.

“Historically a good amount of our product went to the U.S. government, which kept prices stable,
especially for skim products,” says Dorland, who holds an MBA in business and finance. “Therefore, once
every few years, butter or cheese would have a run-up and fall back down. As a result, milk and dairy
product prices played within a rather tight range, a factor that contributed to our belief that demand
was rather inelastic. Today, that is not the case as the government is no longer one of our best
customers.”

Additionally, when it comes to fluid milk, there are many beverage alternatives whose prices are far
more stable. “With all of those factors, we do see that consumers are price sensitive, especially when it
comes to fluid milk,” she adds. “Butter and cheese are far less so. People like cheese and have been
paying a good amount of money for it this year, which makes me very optimistic about domestic cheese
demand this year.”

The Food Network and the Food and Drug Administration have done a lot to help butter demand, notes
Dorland. “In the past, butter was vilified,” she says. “Now butter is best.” With that stamp of approval
and emerging health concerns about margarines and butter substitutes, consumers are making the
switch back to butter. Given lower margarine output and the studies on trans fats, people are unwilling
to switch back. “Again, people are buying butter, but when it gets expensive, they buy a little less,” says
Dorland. “We saw that this fall with the lower commercial disappearance figures.”

So, which food sectors help drive the fluctuation in dairy demand? Dorland points to restaurants and
quick serve restaurants in the domestic market. 

“When prices begin to rise, we see a little less cheese and butter on the menu,” she says. “As an
example, McDonald’s may replace the double cheeseburger with the cheeseburger and eventually the
hamburger. Pizza outlets run fewer promotions and ads. What appear to be very small changes can
swing the market quickly to an over-supplied situation. Add to these consumers buying a little less at the
store and demand eases back. The opposite is also true.

Source: https://www.agweb.com/article/

Based on the article provided, answer the following questions:

a. Describe the concept of price elasticity of demand.

Price elasticity of demand measures the responsiveness of the quantity demanded to a change in price,
measured by dividing the percentage change in the quantity demanded of a product by the percentage
change in the product’s price. (Percentage change in quantity demanded due to the change in price)

b. Using graphs, compare between elastic and inelastic demand.

c. Suppose the price of milk in February 2010 was about RM1.75 per litre, and 15 million litres
were sold, a day. However, in March 2010, the price was about $1.60 per litre, and 16
million litres were sold, a day.
Use the midpoint formula to calculate the price elasticity of demand for milk. Determine if
milk (in this scenario) tends to be elastic or inelastic.

P1: 1.75 P2: 1.65 Q1: 15 million Q2: 16 million

(Q 2−Q 1) ( P 2−P 1)
Price elasticity of demand= ÷
Q 1+Q 2 P 1+ P 2
( ) ( )
2 2

(16−15) (1.75−1.65)
Price elasticity of demand= ÷ =0.0645/0.0896=−0.72=0.72
15+ 16 1.65+1.75
( ) ( )
2 2

d. Based on the article above, identify ONE reason why milk no longer has an inelastic demand.
The availability of close substitutes to the goods – there are many beverage alternatives whose price are
far more stable than milk in the market. When a product has more substitutes available, it will have a
more elastic demand.

e. Dairy products are often known to be inelastic. Critically evaluate THREE determinants of
price elasticity of demand for dairy products.

Passage of time: Short passage of time, consumer cannot switch to other good in short time
Luxuries versus necessities: Milk is a necessity, quantity demand will be less responsive
Share of a good in a consumer’s budget: Milk is only a small portion in daily budget