Assignment 2 – Elasticity

Solutions
Problem 1 (2 Marks)

Yesterday, the price of envelopes was Rs.3 a box, and Jannat was willing to buy 10 boxes.
Today, the price has gone up to Rs.3.75 a box, and Jannat is now willing to buy 8 boxes. Is
Jannat's demand for envelopes elastic or inelastic? What is Jannat's elasticity of demand?

Solution
To find Jannat's elasticity of demand, we need to divide the percent change in quantity by the
percent change in price. 

% Change in Quantity = (8 - 10)/(10) = -0.20 = -20% 

% Change in Price = (3.75 - 3.00)/(3.00) = 0.25 = 25% 
Elasticity = |(-20%)/(25%)| = |-0.8| = 0.8 

Her elasticity of demand is the absolute value of -0.8, or 0.8. Jannat's elasticity of demand is
inelastic, since it is less than 1.

Problem 2 (2 Marks)

If Nayan's elasticity of demand for chocolates is constantly 0.9, and he buys 4 chocolates when
the price is Rs.1.50 per chocolate, how many will he buy when the price is Rs.1.00 per
chocolate?

Solution
This time, we are using elasticity to find quantity, instead of the other way around. We will use
the same formula, plug in what we know, and solve from there. 
Price Elasticity = %Change in Quantity/%Change in Price

%Change in Quantity = (X – 4)/4 

Therefore : 
Elasticity = 0.9 = |((X – 4)/4)/(% Change in Price)| 
% Change in Price = (1.00 - 1.50)/(1.50) = -33% 
0.9 = |(X – 4)/4)/(-33%)| 
|((X - 4)/4)| = 0.3 
0.3 = (X - 4)/4 
X = 5.2 
Since Nayan may not buy fractions of chocolates, he may buy 5 chocolates when the price
drops to Rs.1.00 per chocolate.

Problem 3 (1 Marks)

Which of the following goods are likely to have elastic demand, and which are likely to have
inelastic demand? 
Kerosene oil, Pepsi, Chocolate, Water, Heart medication, Rugs
Solution

Elastic demand: Pepsi, chocolate 

Inelastic demand: Kerosene oil, water, and heart medication

Problem 4 (1 Marks)

If supply is unit elastic and demand is inelastic, a shift in which curve would affect quantity
more? Price more?

Solution
Shifting the demand curve would affect quantity more, and shifting the supply curve would
affect price more.

Problem 5 (2 x 2 = 4 Marks)
Kareena advertises to sell biscuits for Rs.4 a dozen. She sells 50 dozen, and decides that she can
charge more. She raises the price to Rs.6 a dozen and sells 40 dozen. What is the elasticity of
demand? Assuming that the elasticity of demand is constant, how many would she sell if the
price were Rs.10 a box?

Solution
To find the elasticity of demand, we need to divide the percent change in quantity by the percent
change in price. 
% Change in Quantity = (40 - 50)/(50) = -0.20 = -20% 
% Change in Price = (6.00 - 4.00)/(4.00) = 0.50 = 50% 
Elasticity = |(-20%)/(50%)| = |-0.4| = 0.4 
The elasticity of demand is 0.4 (elastic). 
To find the quantity when the price is Rs.10 a box, we use the same formula: 
Elasticity = 0.4 = |(% Change in Quantity)/(% Change in Price)| 
% Change in Price = (10.00 - 4.00)/(4.00) = 1.5 = 150% 
Remember that before taking the absolute value, elasticity was -0.4, so use -0.4 to calculate the
changes in quantity, or you will end up with a big increase in consumption, instead of a
decrease! 
-0.4 = |(% Change in Quantity)/(150%)| = |(%Change in Quantity)| = -60% = -0.6 
-0.6 = (X - 50)/50 => X = 20 
The new demand at Rs.10 a dozen will be 20 dozen biscuits.

Problem 6 (2 x 4 = 8 Marks)

Suppose a firm sells 20,000 units when the price is Rs.16, but sells 30,000 units when the price
falls to Rs.14.

a. Calculate the percentage change in the quantity sold over this price range using the
midpoint formula.
b. Calculate the percentage change in the price using the midpoint formula.
c. Find the price elasticity of demand over this range of prices. State whether demand is
elastic or inelastic over this range.
d. Suppose the firm's elasticity of demand is constant over a large range of prices, equal to
the value found in part c. If the price were to fall another 4%, what should the firm
predict will happen to its quantity sold?

Solution

a. The midpoint formula uses the average of the two quantities as the reference point for
computing the percentage change.
The percentage change in quantity is (30,000 – 20,000)/25,000 = 0.40, or 40%.
b. The percentage change in price is (16 – 14)/15 = 0.133, or 13.3%.
c. The price elasticity of demand is the ratio of the percentage change in quantity to the
percentage change in price.
Ed = 40/13.3 = 3. Since Ed is bigger than one, demand is elastic.
d. The elasticity of demand equals the percentage change in quantity divided by the
percentage change in price. Rearranging this relationship, the percentage change in
quantity is equal to the elasticity of demand times the percentage change in price.
Ed = 3 and the price change is 4%,
So quantity sold will increase by 12%. 12% = 3 x 4%.

Problem 7 (2 x 3 = 6 Marks)

Suppose a firm sells 70 units when the price is Rs.6, but sells 80 units when the price falls to
Rs.4

a. Calculate the firm's revenue at each of the prices.

b. Use the total-revenue test to determine whether demand is elastic or inelastic over this
range.
 c. Verify your previous answer by calculating the elasticity of demand using the midpoint
formula.

Solution

a. Revenue equals price times quantity sold.

At P = Rs.6, revenue = Rs.420. (Rs.420 = Rs.6 x 70)
At P = Rs.4, revenue = Rs.4 x 80 = Rs.320.
b. Revenue falls when the price falls, suggesting demand is inelastic over this range.
c. Ed = [(80 – 70)/75] / [(6 – 4)/5] = .133/.40 = .33, or 1/3. This is less than one, verifying
that demand is inelastic.

Problem 8 (2 x 3 = 6 Marks)

Market research revealed that the market demand function for home exercise equipment is
Q = 2400 – 2P − 15Pv
Where P is the price of exercise equipment and Pv is the price of exercise videos.
The current price of exercise equipment is 300 and the current price of exercise videos is 20.

a. Given these prices, calculate the own-price elasticity of demand for exercise equipment.
b. Are exercise videos and exercise equipment complements or substitutes?
c. Suppose the price of exercise videos increases to 40. Does the own-price elasticity of
demand increase or decrease?

Solution:
a. Plug in P and Pv = 20 to obtain the Quantity at P = 300, Pv = 20
Q = 1500
Ep = dQ/dP*(P/Q)
Elasticity Ep = 2(300/1500) = 0.4.
b. Videos and equipment are complements, because a higher price for videos makes demand
for equipment go down.
c. If instead Pv = 40, the demand curve is Q = 1800 − 2P
Hence, elasticity when P = 300 is Ep = (2) *(300/1200) = 0.5
Demand has become more elastic