BASIC ECONOMICS

TUTORIAL 3
Elasticity and Its Application

THE TUTORIAL
This week’s tutorial looks at Elasticity and Its Application. Please prepare these problems
prior to attending tutorials.
 Quick Quiz (Text book)
- Chapter 5
 Problems and Applications (Text book)
- Chapter 5 (1, 2, 3,7, 8)
 True/False
 Multiple choice

READING GUIDE
Review Chapter 5 of Principles of Economics (9th edition) – N. Gregory Mankiw as
preparation for this tutorial. You should also look overcarefully your lectures notes for
Week 3.

CHAPTER 5 - SUMMARY

Price Elasticity of Demand

1

- The price elasticity of demand measures how much the quantity demanded (Qd)
responds to a change in price (P)
- Price elasticity can be calculated by multiplying the slope of demand (∆Q/∆P) times the
ratio of price to quantity (P/Q)

Note: Along a D curve, P and Q move

in opposite directions, which would
make price elasticity negative. We will
drop the minus sign and report all price
elasticities as positive numbers.

- Price Elasticity of Demand Using the Midpoint Formula: The midpoint formula is
preferable when calculating the price elasticity of demand because it gives the same
answer regardless of the direction of the change

Example: Use the following information to calculate the price elasticity of demand for
hotel rooms: if P = $70, Qd = 5000; if P = $90, Qd = 3000

Answers:

Use midpoint method to calculate % change in Qd

% change in P

The price elasticity of demand equals:

- The price elasticity of demand determines whether the demand curve is steep or
flat

1. Perfectly inelastic demand

D curve: vertical

2. Inelastic demand

D curve: relatively steep

3. Unit elastic demand

D curve: intermediate
slope
4. Elastic demand

D curve: relatively flat

5. Perfectly elastic demand

D curve: horizontal

- Elasticity of a Linear Demand

+ At points with a low price and high quantity, the
demand curve is inelastic

+ At points with a high price and low quantity, the

demand curve is elastic

- Price Elasticity and Total Revenue

 TR reaches a maximum at the rate of
output where D is unit elastic

- Factors Affecting Price Elasticity of Demand

+ Availability of substitutes: The better & more numerous the substitutes for a good,
the more elastic is demand
+ Percentage of consumer’s budget: The greater the percentage of the consumer’s
budget spent on the good, the more elastic is demand
+ Time period of adjustment: The longer the time period consumers have to adjust to
price changes, the more elastic is demand
+ Necessities versus Luxuries: Luxuries have a more elastic demand
+ Definition of the market: The more finely defined the market the more elastic the
demand. The more aggregate the definition of the market the more inelastic the
demand

Income Elasticity of Demand

2

- The income elasticity of demand measures how the quantity demanded changes

as consumer income changes

- Midpoint Method
 Normal goods Inferior goods

EDI > 0 EDI < 0

I,Q I,Q

I,Q I,Q

Cross – price Elasticity of Demand

3

- The cross-price elasticity of demand measures how the quantity demanded of one
good responds to a change in the price of another good

- Midpoint Method

If the products are... Then the cross-price elasticity

of demand will be...
substitutes positive

complements negative

unrelated zero
 Price Elasticity of Supply
4

- The price elasticity of supply measures how much the quantity supplied (QS) responds
to a change in price (P)

- Midpoint Method

1. Perfectly inelastic supply

S curve: vertical

2. Inelastic supply

S curve: relatively
steep
3. Unit elastic supply

S curve: intermediate
slope

4. Elastic supply

S curve: relatively flat

5. Perfectly elastic supply

S curve: horizontal
- How the Price Elasticity of Supply Can Vary

The elasticity of supply may be very

high at low levels of quantity supplied
and very low at high levels of quantity
supplied

- The Determinants of Supply Elasticity

+ The more easily sellers can change the quantity they produce, the greater the price
elasticity of supply.

+ For many goods, price elasticity of supply is greater in the long run than in the short
run.

TRUE/FALSE

TRUE FALSE
1. Necessities tend to have inelastic demands, whereas luxuries have
elastic demands
2. The demand for soap is more elastic than the demand for Dove soap
3. The demand for gasoline will respond more to a change in price
over a period of five weeks than over a period of five years
4. Suppose that when the price rises by 20% for a particular good, the
quantity demanded of that good falls by 10%. The price elasticity
of demand for this good is equal to 2.0
5. If a firm is facing elastic demand, then the firm should decrease
price to increase revenue
6. Normal goods have negative income elasticities of demand, while
inferior goods have positive income elasticities of demand
7. Cross-price elasticity is used to determine whether goods are
inferior or normal goods
8. Supply tends to be more elastic in the short run and more inelastic
in the long run
9. A government program that reduces land under cultivation hurts
farmers but helps consumers
10. OPEC failed to maintain a high price of oil in the long run, partly
because both the supply of oil and the demand for oil are more
elastic in the long run than in the short run

SHORT – ANSWER QUESTIONS

1. Consider the following pairs of goods. For which of the two goods would you
expect the demand to be more price elastic? Why?
a) water or diamonds
b) insulin or nasal decongestant spray
c) food in general or breakfast cereal
d) gasoline over the course of a week or gasoline over the course of a year
e) personal computers or IBM personal computers.
2. Use the graph shown to answer the following questions. Put the correct letter(s) in
the blank.
Price
A

Demand
C Quantity

a) The elastic section of the graph is represented by section from __.

 b) The inelastic section of the graph is represented by section from __.
c) The unit elastic section of the graph is represented by section ___.
d) The portion of the graph in which a decrease in price would cause total revenue
to fall would be from ___.
e) The portion of the graph in which a decrease in price would cause total revenue
to rise would be from ____.
f) The portion of the graph in which a decrease in price would not cause a change
in total revenue would be ___.
g) The section of the graph in which total revenue would be at a maximum would
be ___.
h) The section of the graph in which elasticity is greater than 1 is ___.
i) The section of the graph in which elasticity is equal to 1 is __.
j) The section of the graph in which elasticity is less than 1 is ___.

MULTIPLE CHOICE

1. Which of the following is not a determinant of the price elasticity of demand for a
good?
Ⓐ the time horizon Ⓒ the definition of the market for the
good ........
Ⓑ the steepness or flatness of the Ⓓ the availability of substitutes for the
supply curve for the good good
2. For which of the following goods would demand be most elastic?
Ⓐ clothing Ⓒ Tommy Hilfiger jeans
Ⓑ blue jeans Ⓓ All three would have the same ........
elasticity of demand since they are all
related.
3. Whether a good is a luxury or necessity depends on
Ⓐ the price of the good Ⓒ the intrinsic properties of the good ........
Ⓑ the preferences of the buyer Ⓓ how scarce the good is.
4. Suppose there is a 6 percent increase in the price of good X and a resulting 6
percent decrease in the quantity of X demanded. Price elasticity of demand for X is
Ⓐ 0 Ⓒ6 ........
Ⓑ1 Ⓓ 36
5. If the price elasticity of demand for a good is 4.0, then a 10 percent increase in
price results in a
Ⓐ 0.4 percent decrease in the Ⓒ 4 percent decrease in the quantity
quantity demanded demanded ........
Ⓑ 2.5 percent decrease in the Ⓓ 40 percent decrease in the quantity
quantity demanded demanded
6. For a particular good, a 2 percent increase in price causes a 12 percent decrease in
quantity demanded. Which of the following statements is most likely applicable to
this good?
Ⓐ There are no close substitutes for Ⓒ The market for the good is broadly ........
this good defined
Ⓑ The good is a luxury Ⓓ The relevant time horizon is short
7. When we move upward and to the left along a linear, downward-sloping demand
curve, price elasticity of demand
Ⓐ first becomes smaller, then larger Ⓒ always becomes smaller ........
Ⓑ always becomes larger Ⓓ first becomes larger, then smaller
Figure 3-1
Price

A
B
C
D D
C ........
B
A Quantity

8. Refer to Figure 3-1. The demand curve representing the demand for a luxury
good with several close substitutes is
Ⓐ A ⒸC
ⒷB ⒹD
9. Refer to Figure 3-1. Ann says he would buy one cup of coffee per day regardless
of the price. If this is true, then Atog's demand for coffee is represented by demand
curve ........
ⒶA ⒸC
ⒷB ⒹD
10. If demand is price inelastic, then
Ⓐ buyers do not respond much to a Ⓒ buyers do not alter their quantities
change in price demanded much in response to
advertising, fads, or general changes ........
in tastes
Ⓑ buyers respond substantially to a Ⓓ the demand curve is very flat
change in price, but the response
is very slow
11. When the price of a good is $5, the quantity demanded is 100 units per month;
when the price is $7, the quantity demanded is 80 units per month. Using the
midpoint method, the price elasticity of demand is about ........
Ⓐ 0.22 Ⓒ 1.33
Ⓑ 0.67 Ⓓ 1.50
12. When the rental price of DVD movies is $4, Denise rents five per month. When the
price is $3, she rents nine per month. Denise's demand for DVD rentals is

Ⓐ elastic, and her demand curve Ⓒ inelastic, and her demand curve ........
would be relatively flat would be relatively flat
Ⓑ elastic, and her demand curve Ⓓ inelastic, and her demand curve
would be relatively steep would be relatively steep
13. Suppose demand is perfectly elastic, and the supply of the good in question
decreases. As a result,
Ⓐ the equilibrium quantity Ⓒ the equilibrium quantity and the
decreases, and the equilibrium equilibrium price both are unchanged
........
price is unchanged
Ⓑ the equilibrium price increases, Ⓓ buyers’ total expenditure on the good
and the equilibrium quantity is is unchanged
unchanged
14. A perfectly inelastic demand implies that buyers
Ⓐ decrease their purchases when the Ⓒ increase their purchases only slightly
price rises when the price falls
........
Ⓑ purchase the same amount as Ⓓ respond substantially to an increase in
before when the price rises or price
falls
15. When the price of good A is $50, the quantity demanded of good A is 500 units.
When the price of good A rises to $70, the quantity demanded of good A falls to
400 units. Using the midpoint method,

Ⓐ the price elasticity of demand for Ⓒ the price elasticity of demand for good
good A is 1.50, and an increase in A is 0.67, and an increase in price will
price will result in an increase in result in an increase in total revenue ........
total revenue for good A for good A
Ⓑ the price elasticity of demand for Ⓓ the price elasticity of demand for good
good A is 1.50, and an increase in A is 0.67, and an increase in price will
price will result in a decrease in result in a decrease in total revenue
total revenue for good A for good A
16. Barb's Bakery earned $200 in total revenue last month when it sold 100 loaves of
bread. This month it earned $300 in total revenue when it sold 60 loaves of bread.
The price elasticity of demand for Barb's bread is ........
Ⓐ 0.27 Ⓒ 1.25
Ⓑ 0.58 Ⓓ 1.71
17. If a change in the price of a good results in no change in total revenue, then
Ⓐ the demand for the good must be Ⓒ the demand for the good must be unit
elastic elastic ........
Ⓑ the demand for the good must be Ⓓ buyers must not respond very much to
inelastic a change in price
18. In which of the following situations will total revenue increase?
Ⓐ Price elasticity of demand is 1.2, Ⓒ Price elasticity of demand is 3.0, and
and the price of the good the price of the good decreases
decreases ........
Ⓑ Price elasticity of demand is 0.5, Ⓓ All of the above are correct
and the price of the good
increases
19. Holding all other forces constant, if increasing the price of a good leads to an
increase in total revenue, then the demand for the good must be
Ⓐ unit elastic Ⓒ elastic
........
Ⓑ inelastic Ⓓ None of the above is correct, since a
price increase always leads to an
increase in total revenue
20. On a downward-sloping linear demand curve, total revenue reaches its maximum
value at the ........
Ⓐ midpoint of the demand curve Ⓒ upper end of the demand curve
 Ⓑ lower end of the demand curve Ⓓ It is impossible to tell without
knowing prices and quantities
demanded
21. Last year, Sheila bought 6 pairs of shoes when her income was $40,000. This year,
her income is $52,000 and she purchased 7 pairs of shoes. Holding other factors
constant and using the midpoint method, it follows that Sheila’s income elasticity
of demand is about
Ⓐ 0.59, and Sheila regards shoes as Ⓒ 1.7, and Sheila regards shoes as an ........
an inferior good inferior good
Ⓑ 0.59, and Sheila regards shoes as Ⓓ 1.7, and Sheila regards shoes as a
a normal good normal good
22. Necessities such as food and clothing tend to have
Ⓐ high price elasticities of demand Ⓒ low price elasticities of demand and
and high income elasticities of high income elasticities of demand
demand ........
Ⓑ high price elasticities of demand Ⓓ low price elasticities of demand and
and low income elasticities of low income elasticities of demand
demand
23. To determine whether a good is considered normal or inferior, one could examine
the value of the
Ⓐ income elasticity of demand for Ⓒ price elasticity of supply for that good
that good ........
Ⓑ price elasticity of demand for that Ⓓ cross-price elasticity of demand for
good that good
24. May's income elasticity of demand for football tickets is 1.50. All else equal, this
means that if her income increases by 20 percent, she will buy
Ⓐ 150 percent more football tickets Ⓒ 30 percent more football tickets ........
Ⓑ 50 percent more football tickets Ⓓ 20 percent more football tickets
25. Suppose that when the price of good X falls from $10 to $8, the quantity demanded
of good Y rises from 20 units to 25 units. Using the midpoint method,
Ⓐ the cross-price elasticity of Ⓒ the cross-price elasticity of demand is
demand is -1.0, and X and Y are 1.0, and X and Y are complements
complements ........
Ⓑ the cross-price elasticity of Ⓓ the cross-price elasticity of demand is
demand is -1.0, and X and Y are 1.0, and X and Y are substitutes
substitutes
26. Last month, sellers of good Y took in $100 in total revenue on sales of 50 units of
good Y. This month sellers of good Y raised their price and took in $120 in total
revenue on sales of 40 units of good Y. At the same time, the price of good X
stayed the same, but sales of good X increased from 20 units to 40 units. We can
conclude that goods X and Y are ........
Ⓐ substitutes, and have a cross-price Ⓒ substitutes, and have a cross-price
elasticity of 0.60 elasticity of 1.67
Ⓑ complements, and have a cross- Ⓓ complements, and have a cross-price
price elasticity of 0.60 elasticity of 1.67
27. The cross-price elasticity of demand can tell us whether goods are
Ⓐ normal or inferior Ⓒ luxuries or necessities ........
Ⓑ elastic or inelastic Ⓓ complements or substitutes
28. Frequently, in the short run, the quantity supplied of a good is
Ⓐ impossible, or nearly impossible, Ⓒ determined by the quantity demanded
to measure of the good ........
Ⓑ not very responsive to price Ⓓ determined by psychological forces
changes and other non-economic forces
29. When a supply curve is relatively flat
Ⓐ sellers are not at all responsive to Ⓒ the supply is relatively elastic
a change in price
........
Ⓑ the equilibrium price changes Ⓓ the supply is relatively inelastic
substantially when the demand
for the good changes
30. If a 25% change in price results in a 40% change in quantity supplied, then the
price elasticity of supply is
Ⓐ 0.63, and supply is elastic Ⓒ 1.60, and supply is elastic ........
Ⓑ 0.63, and supply is inelastic Ⓓ 1.60, and supply is inelastic
31. If the price elasticity of supply is 1.5, and a price increase led to a 1.8% increase in
quantity supplied, then the price increase amounted to
Ⓐ 0.67% Ⓒ 1.20% ........
Ⓑ 0.83% Ⓓ 2.70%

32. Suppose the price elasticity of supply for how-to books is 0.3 in the short run and
1.2 in the long run. If an increase in the demand for how-to books causes the price
of how-to books to increase by 20%, then the quantity supplied of how-to books
will increase by ........
Ⓐ 0.67% in the short run and 0.17% Ⓒ 6% in the short run and 24% in the
in the long run long run
 Ⓑ 3% in the short run and 1.2% in Ⓓ 66.7% in the short run and 16.7% in
the long run the long run
Figure 3-2
The following figure shows the supply curve for a particular good
Price

430 Supply

220

........
100

40
16
2 5 9 14 20 Quantity

33. Refer to Figure 3-2. Over which range is the supply curve in this figure the most
elastic?
Ⓐ Between $16 and $40 Ⓒ Between $100 and $220
Ⓑ Between $40 and $100 Ⓓ Between $220 and $430
34. Refer to Figure 3-2. Over which range is the supply curve in this figure the least
elastic?
Ⓐ Between $16 and $40 Ⓒ Between $100 and $220 ........
Ⓑ Between $40 and $100 Ⓓ Between $220 and $430
35. Refer to Figure 3-2. Using the midpoint method, what is the price elasticity of
supply between $16 and $40?
Ⓐ 0.125 Ⓒ 1.0 ........
Ⓑ 0.86 Ⓓ 2.5
36. Suppose that an increase in the price of carrots from $1.30 to $1.80 per pound
increases the quantity of carrots that carrot farmers produce from 1.2 million
pounds to 1.6 million pounds. Using the midpoint method, what is the approximate
value of the price elasticity of supply? ........
Ⓐ 0.67 Ⓒ 1.00
Ⓑ 0.89 Ⓓ 1.13
37. Refer to Figure 3-3. Which supply curve is most likely relevant over a very long
period of time?
Ⓐ S1 Ⓒ S3 ........
Ⓑ S2 Ⓓ None of the supply curves is
perfectly inelastic
38. An advance in farm technology that results in an increased market supply is
Ⓐ good for farmers because it raises Ⓒ good for farmers because it raises
prices for their products but bad prices for their products and also good
for consumers because it raises for consumers because more output is
prices consumers pay for food available for consumption ........
Ⓑ bad for farmers because total Ⓓ bad for farmers because total revenue
revenue will fall but good for will fall and bad for consumers
consumers because prices for because farmers will raise the price of
food will fall food to increase their total revenue
39. If corn farmers know that the demand for corn is inelastic, and they want to
increase their total revenue, they should all
Ⓐ plant more corn so that they Ⓒ reduce the number of acres they plant
would be able to sell more each in corn
year ........
Ⓑ increase spending on fertilizer in Ⓓ contribute to a fund that promotes
an attempt to produce more corn technological advances in corn
on the acres they farm production
40. If the price elasticity of supply for a good is equal to infinity, then
Ⓐ the supply curve is vertical Ⓒ the supply curve also has a slope
equal to infinity ........
Ⓑ the supply curve is horizontal Ⓓ the quantity supplied is constant
regardless of the price