CHAPTER 6 Elasticity
Test Yourself
2. (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.
(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. (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).
5. 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 (15,000/5) × (22.5/17,500) = 3.86. This formula is a rearangement of the terms from the formula in the text.
6. The elasticity is the percentage change in quantity divided by the percentage change in price and is equal to 0.3. Since the 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.
Discussion Questions
1. 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.
3. 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.
4. 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.