CHAPTER 5: ELASTICITY OF DEMAND AND SUPPLY

1. For each of following pairs of goods, which good would you expect to have more
elastic demand and why?
a. Required textbooks or mystery novels
Mystery novels have more elastic demand than required textbooks, because mystery
novels have close substitutes and are a luxury good, while required textbooks are a
necessity with no close substitutes. If the price of mystery novels were to rise, readers
could substitute other types of novels, or buy fewer novels altogether. But if the price of
required textbooks were to rise, students would have little choice but to pay the higher
price. Thus the quantity demanded of required textbooks is less responsive to price than
the quantity demanded of mystery novels.
b. Beethoven recordings and classical music
Beethoven recordings have more elastic demand than classical music recordings in
general. Beethoven recordings are a narrower market than classical music recordings, so
it's easy to find close substitutes for them. If the price of Beethoven recordings were to
rise, people could substitute other classical recordings, like Mozart. But if the price of all
classical recordings were to rise, substitution would be more difficult (a transition from
classical music to rap is unlikely!). Thus the quantity demanded of classical recordings is
less responsive to price than the quantity demanded of Beethoven recordings.

c. Subway rides during the next 6 months or subway rides during the next 5 years
Heating oil during the next five years has more elastic demand than heating oil during the
next six months. Goods have a more elastic demand over longer time horizons. If the
price of heating oil were to rise temporarily, consumers couldn't switch to other sources
of fuel without great expense. But if the price of heating oil were to be high for a long
time, people would gradually switch to gas or electric heat. As a result, the quantity
demanded of heating oil during the next six months is less responsive to price than the
quantity demanded of heating oil during the next five years.
d. root beer or water
Root beer has more elastic demand than water. Root beer is a luxury with close
substitutes, while water is a necessity with no close substitutes. If the price of water were
to rise, consumers have little choice but to pay the higher price. But if the price of root
beer were to rise, consumers could easily switch to other sodas. So the quantity
demanded of root beer is more responsive to price than the quantity demanded of water.
2. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and
0.7 in the long run.
a. If the price of heating oil rises from $1.80 to $2.20 per gallon, what happens to the
quantity of heating oil demanded in the short run? In the long run?
The percentage change in price is equal to (2.20-1.80)/2.00 = 20%.
If the price elasticity of demand is 0.2, quantity of demanded will fall by 4% in the short
run (E x %P).
If the price elasticity of demand is 0.7, quantity demanded will fall by 14% in the long
run.
b. Why might this elasticity depend on the time horizon?
Because over time, consumers can make adjustments to their homes by purchasing
alternative heat sources such as natural gas or electric furnaces. Thus, they can respond
more easily to the change in the price of heating oil in the long run than in the short run.

3. A price change causes the quantity demanded of a good to decrease by 30 percent,

while the total revenue of that good increases by 15 percent. Is the demand curve
elastic or inelastic? Explain

4. The price of coffee rose sharply last month, while the quantity sold remained the
same. Five people suggest various explanations:
Leonard: Demand increased, but supply was perfectly inelastic.

5. Suppose that your demand schedule for pizza is as follows:

a. Use the midpoint method to calculate your price elasticity of demand as the price of
pizza increases from $8 to $10 if (i) your income is $20,000 and (ii) your income is
$24,000.
- If your income is $20,000, your price elasticity of demand as the price of compact discs
rises from $8 to $10 is [(40 - 32)/36]/[(10 - 8)/9] =0.22/0.22 = 1.
- If your income is $24,000, the elasticity is [(50 - 45)/47.5]/[(10 - 8)/9] = 0.11/0.22 = 0.5
b. Calculate your income elasticity of demand as your income increase form $20,000 to
$24,000 if (i) the price is $12 and (ii) the price is $16
- If the price is $12, your income elasticity of demand as your income increases from
$20,000 to $12,000 is [(30 - 24)/27] / [(24,000 - 20,000)/22,000] = 0.22/0.18 = 1.22.
- If the price is $16, your income elasticity of demand as your income increases from
$10,000 to $12,000 is [(12 - 8)/10] / [(24,000 - 20,000)/22,000] = 0.40/0.18 = 2.2.

6. Two drivers, Walt and Jessie, each drive up to a gas station. Before looking at the
price, each places an order. Walt says, “I’d like 10 gallons of gas.” Jessie says, “I’d
like $10 worth of gas.” What is each driver’s price elasticity of demand?
- Walt's price elasticity of demand is zero, since he wants the same quantity regardless of
the price.
- Jessie's price elasticity of demand is one, since he spends the same amount on gas, no
matter what the price, which means his percentage change in quantity is equal to the
percentage change in price.
7. The New York Times reported (Feb. 17, 1996) that subway ridership declined
after a fare increase: “There were nearly four million fewer riders in December
1995, the first full month after the price of a token increased 25 cents to $1.50, than
in the previous December, a 4.3 percent decline.”
a. Use these data to estimate the price elasticity of demand for subway rides.
With a 4.3 percent decline in quantity following an estimated 17 percent increase in price,
the price elasticity of demand is only 4.3/0.17 = 0.215, which is fairly inelastic.
b. According to your estimate, what happens to the Transit Authority’s revenue when the
fare rises?
With inelastic demand, the Transit Authority's revenue rises when the fare rises.
c. Why might your estimate of the elasticity be unreliable?
The elasticity estimate might be unreliable because it is only the first month after the fare
increase. As time goes by, people may switch to other means of transportation in
response to the price increase. So the elasticity may be larger in the long run than it is in
the short run.
8. Explain why the following might be true: A drought around the world raises the
total revenue that farmers receive from the sale of grain, but a drought only in
Kansas reduces the total revenue that Kansas farmers receive.
A worldwide drought could increase the total revenue of farmers if the price elasticity of
demand for grain is inelastic. The drought reduces the supply of grain, but if demand is
inelastic, the reduction of supply causes a large increase in price. Total farm revenue
would rise as a result. If there's only a drought in Kansas, Kansas’ production isn't a
large enough proportion of the total farm product to have much impact on the price. As a
result, price does not change (or changes by only a slight amount), while the output of
Kansas farmers declines, thus reducing their income.