Chapter 6/Demand and Elasticity

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CHAPTER 6
DEMAND AND ELASTICITY
TEST YOURSELF
1. What variables other than price and advertising are likely to affect the quantity demanded
of a product?
The answer depends upon the product, but general variables include tastes, prestige value
of the product, income levels, population, prices of substitutes and complements, and new
uses to which the product can be put.
2. Describe the probable shifts in the demand curves for
a. Airplane trips when airlines’ on-time performance improves
b. Automobiles when airplane fares double
c. Automobiles when gasoline prices double
d. Electricity when the average temperature in the United States rises during a
particular year (Note: The demand curve for electricity in Maine and the demand
curve for electricity in Florida should respond in different ways. Why?)
(a) Increase: shift to the right. Airplane trips are more attractive when their punctuality
improves.
(b) Increase: shift to the right. Airplane trips are a substitute for automobiles; thus
automobiles are more attractive when airplane fares increase.

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 Chapter 6/Demand and Elasticity

(c) Reduction: shift to the left. Gasoline is a complement to automobiles; thus automobiles
are less attractive when gasoline prices increase.
(d) Demand will decrease (shift to the left) in Maine because less electricity will be wanted
for heating buildings in winter. Demand will increase (shift to the right) in Florida,
because more electricity will be wanted for air conditioning. The rise in temperature is
unlikely to have much effect on air conditioning in Maine or on home heating in
Florida.
3. Taxes on particular goods discourage their consumption. Economists say that such taxes
“distort consumer demands.” In terms of the elasticity of demand or elasticity of supply
for the commodities in question, what sort of goods would you choose to tax to achieve
the following objectives?
a. Collect a large amount of tax revenue
b. Distort demand as little as possible
c. Discourage consumption of harmful commodities
d. Discourage production of polluting commodities
(a) Goods with low price elasticity of demand (inelastic demand).
(b) Goods with low price elasticity of demand (inelastic demand).
(c) Goods with high price elasticity of demand (elastic demand).
(d) Goods with high price elasticity of demand (elastic demand).
4. Give examples of commodities whose demand you would expect to be elastic and
commodities whose demand you would expect to be inelastic.
Elastic: Any particular food, like carrots or pork chops (since there are close substitutes),
apartments in a particular building (since they require a lot of a consumer’s budget, and
since there are close substitutes), vacation trips to the Caribbean (since they are not really
needed, and since there are close substitutes).
Inelastic: Food in general (there is no substitute), housing in general (people resist reducing
the quality of their housing when prices rise), salt (so insignificant in a budget that one
hardly notices a price change), tobacco and liquor (many consumers are addicted).
5. A rise in the price of a certain commodity from $20 to $25 reduces quantity demanded
from 25,000 to 10,000 units. Calculate the price elasticity of demand.
Using the formula in the text, (change in quantity/change in price) times (price/quantity),
where price and quantity are the average of the beginning and ending values, the elasticity
is (15,000/17,500) / (5/22.5) = 0.857/0.222 = 3.86
6. If the price elasticity of demand for gasoline is 0.3 and the current price is $3.20 per
gallon, what rise in the price of gasoline will reduce its consumption by 10 percent?
The elasticity is the percentage change in quantity divided by the percentage change in
price and is equal to 0.3. Since the desired percentage change is quantity is 10%, the
percentage change in price is 10%/0.3 = 33.3%. In finding the new gasoline price, however,
there is an ambiguity. A 33.3% increase above $1.20 a gallon would bring the price to
$1.60. On the other hand, the text recommends that the base for calculating a percentage
change should be half way between the beginning and ending values. In that case (P1 –
P0)/[(P1 + P0)/2] = 0.33; (P1 – P0) = 0.33[(P1 + P0)/2]; therefore (P1 – $1.20)/[(P1 +
$1.20)/2] = 0.33; and the new price is $1.68.
7. Which of the following product pairs would you expect to be substitutes, and which
would you expect to be complements?
a. Shoes and sneakers
b. Gasoline and sport-utility vehicles
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 Chapter 6/Demand and Elasticity

c. Bread and butter

d. Compact discs and digital music files
Complements: (b) and (c)
Substitutes: (a) and (d)
8. For each of the product pairs given in Test Yourself Question 7, what would you guess
about the products’ cross elasticity of demand?
a. Do you expect it to be positive or negative?
b. Do you expect it to be a large or small number? Why?
Shoes and sneakers: The cross elasticity is positive because they are substitutes, but likely
to be rather low because the two are normally used on quite different occasions for very
different purposes.
Gas and sport utility vehicles: The cross elasticity is negative because they are
complements, and high, because when gas prices rise it becomes much more expensive to
operate a sport utility vehicle.
Bread and butter: The cross elasticity is negative because they are complements, but low
because there are many uses for each which do not require the other.
Instant and regular film: The cross elasticity is positive because they are substitutes, and
probably quite high because the degree of substitutability is high; both can produce quite
good pictures.

DISCUSSION QUESTIONS
1. Explain why elasticity of demand is measured in percentages.
Elasticity is calculated in percentages so that it can be a measure of responsiveness that is
not influenced by the units chosen. Suppose, for example, that the quantity of steel bought
rises from 1 to 3 tons when the price falls from $300 to $100. Calculating the absolute
change in units divided by the absolute change in price gives a value of 2/200 = 0.01. If,
instead, steel is measured in pounds, the value is 4000/200 = 20. No one could say which
is the true measure of elasticity. If the changes in both quantity and price are measured in
percentage terms, then it does not matter what units are used—the percentage change in
quantity divided by the percentage change in price (using the numbers in this example) will
always be 200%/200% = 1.
2. Explain why the elasticity of demand formula normally eliminates minus signs.
In the calculation of the price elasticity of demand, the sign of the percentage price change
is almost always the opposite of the sign of the percentage quantity change: if one goes up,
the other goes down. Therefore the ratio of the two would always have a minus sign. Since
this is well understood, it is convenient to omit the minus sign. Thus a higher value of
elasticity indicates that quantity is more responsive to price.
3. Explain why the elasticity of a straight-line demand curve varies from one part of the
curve to another.
Along a straight-line demand curve, the same absolute price reduction (say, $1) is always
associated with the same absolute quantity increase (say, 2 pounds). When price is high
and quantity low, a reduction in price of $1 is a small percentage change in the price, but
an increase in quantity of 2 pounds is a large percentage increase in quantity, so the
elasticity is high. When price is low and quantity high, on the other hand, the situation is
reversed, and the elasticity is low. The price elasticity of demand falls as one moves down
along a straight-line demand curve.

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 Chapter 6/Demand and Elasticity

4. A rise in the price of a product whose demand is elastic will reduce the total revenue of
the firm. Explain.
Revenue is equal to price times quantity. When the demand curve is elastic, the percentage
decline in quantity exceeds the percentage rise in price, and therefore the product of the
two falls. In other words, if demand is elastic and the seller increases price, a large
percentage of existing customers will no longer purchase that good. The remaining
customer will pay the higher price. However, the substantial number of customers that no
longer purchase the good will result in a decrease in total revenue.
5. Name some events that will cause a demand curve to shift.
Changes in tastes, incomes, population, prices of substitutes and complements, advertising,
uses of the product, etc.
6. Explain why the following statement is true: “A firm with a demand curve that is
inelastic at its current output level can always increase its profits by raising its price
and selling less.” (Hint: Refer back to “Price Elasticity of Demand: Its Effect on Total
Revenue and Total Expenditure.”
If the demand curve is inelastic, the percentage decline in quantity will be less than the
percentage increase in price. Therefore revenue will rise when price rises. Costs will not
increase as quantity declines; at the very least they will stay constant, and they will
probably decline. If revenues rise while costs stay constant or decline, profits must rise.

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.