ECO 101H1: Principles of Microeconomics Prof.

Freitas, University of Toronto

Problem set: Elasticity

Questions and Solutions

1) In 2028, the price was $9.50 and 9 units were supplied. In 2029, the price increased to $10.50 and 11 units were
supplied. What is own-price elasticity of supply?
Solution: Elasticity of supply is
%4QS
εS =
%4P
When you have two point with which to calculate elasticity, use the mid-point method. This would make
10.5 − 9.5 1
%4P = 10.5+9.5 =
2
10

and
11 − 9 2
%4QS = 11+9 =
2
10
Putting them together gives us
2
%4QS 10
εS = = 1 =2
%4P 10

Supply is elastic as a 1% change in prices leads to a 2% increase in quantity supplied.

2) For a 2% decrease in quantity what is the % change in price that causes this for the (own) price elasticities in
the questions below?

2a) Own-price elasticity of demand is 2.

D
Solution: Since |εD | = | %4Q
%4P |, plugging in the values gives us

%4QD 0.02
|εD | = | |⇒2=| | ⇒ |%4P | = 0.01 = 1%
%4P %4P
Note: Why am I writing 0.02 instead of just 2? Because it is the technically correct way to write a percentage.
As a shortcut we sometimes write 2 and in a question like this where it is a ratio of percentages, it doesn’t
matter. However in another type of question, for example if the price goes up by 2%, what is the increase in
price? If you calculate the increase in price as P ∗ 2 you will be wrong as you need to use P ∗ 0.02.
2b) Own-price elasticity of demand is 1.

Solution: Following the same logic in part (a)

%4QD 0.02
|εD | = | |⇒1=| | ⇒ |%4P | = 0.02 = 2%
%4P %4P

2c) Own-price elasticity of demand is 0.5.

Solution: Following the same logic in part (a)

%4QD 0.02
|εD | = | | ⇒ 0.5 = | | ⇒ |%4P | = 0.04 = 4%
%4P %4P

3) Assume a 5% increase in price.

3a) If elasticity of demand is 5, what is the resulting change in quantity demanded?

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ECO 101H1: Principles of Microeconomics Prof. Freitas, University of Toronto

Solution: This is a similar type of question to the one above except since you aren’t given starting or ending prices
you can only solve for the resulting percentage change in QD . Although we only solve for absolute values of
own-price demand elasticity, we know that in 101 we are only looking at downward sloping demand. That
means that a complete answer will include not only the percentage change in QD but the direction of change
as well.
%4QD %4QD
|εD | = | |⇒5=| | ⇒ |%4QD | = 0.25
%4P 0.05

When prices increase by 5%, QD decreases by 25%

3b) If elasticity of demand is 1.5 , what is the resulting change in quantity demanded?
D D
Solution: |εD | = | %4Q %4Q D
%4P | ⇒ 1.5 = | 0.05 | ⇒ |%4Q | = 0.075

When prices increase by 5%, QD decreases by 7.5%

4) For each statement below tell us if it is True/False/Uncertain (TFU) and briefly explain your reasoning.
4a) You own a legal marijuana store in Ontario. The price of 1 gram of your product falls from $15 to $12. Your
revenue falls when this happens. TFU: demand for your marijuana is inelastic.
Solution: True. A change just in price is a movement along the demand curve. An increase in price causes a
decrease in quantity demanded. If the quantity demanded fall by a bigger % than the % fall in price, revenues
fall. But here, prices fell and revenues decreased. It must be because the % increase in quantity demanded is
less than the % decrease in price which is the definition of inelastic demand.

4b) Let’s assume that the food trucks outside Robarts operate in a perfectly competitive market. They all sell
identical shawarmas and are price takers. You own one of these trucks. TFU: The demand for your products
is perfectly inelastic.
Solution: False. Since all the trucks sell the same (to the consumers) shawarmas, if you increase your prices, all
your customers will just move to another truck. Since it is assumed to be a perfectly competitive market,
your customers are able to find all the shawarmas they need. If you decrease your price relative to the others,
you get (and by assumption are able to satisfy) all the consumers looking to buy a shawarma. This makes
the demand you face perfectly elastic. A slight change in price leads to a dramatic change in quantity of your
goods demanded.
4c) You own a gas station. The gas is delivered once a month and you can’t get anymore till the next month.
TFU: Your supply of gas on the 15th of the month is perfectly inelastic.
Solution: True. No matter how much the price rises you can’t supply more gas. Even if the price falls, you’re
not going to supply any less gas. Basically the change in quantity is zero for any % change in price. As the
numerator in the elasticity formula is zero, your supply elasticity is zero and hence perfectly inelastic.
5) The demand curve is captured by QD = 450 − 3P .

5a) Calculate own-price elasticity of demand at P = 90 and P = 30, in each case indicating whether demand is
elastic or inelastic.
D
Solution: Elasticity is |εD | = | %4Q
%4P | So far we have been calculating the % change using the mid-point method.
For cases when we are given a demand equation we can do it another way.
Step 1: Let’s take a closer look at what % change is

change 4QD
%4QD = =
original QD
We used the mid-point method when given two points because we don’t want the starting point to matter.
With two points we calculated the point in the middle (i.e. the average) to use in the denominator to address
this. When we have an equation for demand, our lives are easier as we can bring the two extremes used to
calculate the average closer and closer together till they are exactly one point. This way starting point doesn’t

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ECO 101H1: Principles of Microeconomics Prof. Freitas, University of Toronto

matter as we are calculating elasticity at a particular point.

Step 2: Rewrite the elasticity formula as
4QD
%4QD QD 4QD P
|εD | = | |=| 4P
|=| |
%4P P
4P QD

Step 3: From the skills checked on the Math assessment, I know that you know how to figure out the change
in QD (i.e. 4QD ) for a given change in P (i.e. 4P ) given an equation. For this demand curve QD = 450 − 3P
you can see that
4QD
= −3
4P
plugging this back into the elasticity equation we get

4QD P P
|εD | = | D
| = |−3∗ D|
4P Q Q

Step 4: Find the elasticity at the point you are looking for.
Elasticity at P = 30 ⇒ QD = 360 is
P 30 1
|εD | = | − 3 ∗ D
|=|−3∗ |=
Q 360 4
which makes demand inelastic.
Elasticity at P = 90 ⇒ QD = 180 is
P 90 3
|εD | = | − 3 ∗ |=|−3∗ |=
QD 180 2
which makes demand elastic.
Notice that this is a linear demand curve, but elasticity varies along the curve. Make sure you can understand
and explain why this is the case.

5b) What price maximizes total revenue?

Solution: Total revenue is maximized along a linear demand curve at the point where we have unit elasticity i.e.
|εD | = 1. You can find this point in two ways.
Method 1: You use the fact that the unit elastic point is the point exactly halfway along the curve. The
intercept on the P axis is QD = 450 − 3P = 0 ⇒ P = 150. This makes the halfway price point P = 150 2 = 75.
Method 2: You use the elasticity formula from the previous parts to find the point where |εD | = 1

P
|εD | = |−3∗ QD
|
P
1 = 3∗ 450−3P

450 − 3P = 3P
450
P = 6

P = 75

5c) Is the price you found in part (b) the price that maximizes your total profit?
Solution: No. The price we found P = 75 maximizes total revenue. Profit is Revenue-Total Costs. Depending on
what the costs look like there may be another price that maximizes total cost.
However, if marginal cost was zero always then the price would maximize total profits. Why? Every extra
unit costs you zero to make so extra revenue from that unit sold just raises profits.
6) Below is the abstract from the paper “To Borrow or Not to Borrow: Religious Norms and the Elasticity of
Demand for Credit” by Dean Karlan, Adam Osman and Nour Shammout. Feb 2017.

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ECO 101H1: Principles of Microeconomics Prof. Freitas, University of Toronto

“Low utilization of credit in developing countries may be partially due to societal norms. We consider one such
case in Jordan and compare the demand for a new, sharia-compliant product to a non-compliant product. To
comply with the Islamic prohibition on paying or receiving interest, the sharia-compliant product uses a bank
fee rather than interest payment structure, while keeping the economics of the product the same as a comparable
conventional loan. We find that in this largely Muslim country, consumers offered a sharia-compliant loan
increase their application rate from 18% to 22%. We also randomly varied the price of the sharia-compliant
product, and find that the less religious individuals in our sample are twice as elastic with respect to price as
those who are more religious. We find no evidence of differences between those who apply for the conventional
loan and those that apply for the sharia-compliant loan on observable demographics, suggesting that this new
product successfully increases utilization of formal financial services without necessarily pulling in more risky
individuals”

6a) What could be one reason why religious individuals have a lower (absolute) price elasticity of demand for sharia
compliant loans?
Solution: When the price rises, demand reduces as people shift their consumption to different alternatives/substitutes
(or do without which may be more difficult depending on the situation/good). In this case if sharia compliant
loans are important for religious individuals then they have fewer other options to switch to when the price of
a loan rises. This lack of alternatives mean that their demand for sharia compliant loans will decrease slower
than similar non-religious individuals who have more options.
6b) In general, across all individuals, would you expect the elasticity of demand for sharia-compliant loans to be
more or less elastic than the demand for any loans?
Solution: (Own price) demand elasticity (in absolute terms) is, in general, bigger for narrower categories. As
sharia-compliant loans are a subset of all loans, the demand is likely to be more elastic for them compared
to that of all loans. If the price of sharia-compliant loans increases, people can switch to other loans (albeit
reluctantly in the case of religious individuals). However, if the price of all loans (which includes sharia-
compliant loans) increases, there are fewer alternatives in case an individual needs funds making it less likely
they will substitute away.

7) Preventive health products that have public health benefits (e.g. insecticide-treated bednets, water purification
products, and latrine slabs for safe sanitation) in developing countries have a high price sensitivity (i.e. high
absolute own-price demand elasticity). See “The Price is Wrong” J-PAL Bulletin. April 2017. Cambridge,
MA: Abdul Latif Jameel Poverty Action Lab.
7a) If you are selling insecticide-treated bednets to prevent malaria, would raising the prices increase or decrease
revenues for your company?
Solution: We are always looking at downward sloping demand in Eco 101. With elastic demand, when the price
increases, the more than proportional decrease in quantity causes revenues to decrease. Raising prices would
lower revenues for the company.

7b) Given the important of health and the big impact these health interventions have, what could be reasons why
people so price sensitive even at very low prices?
Solution: A high price sensitivity means that for a given increase in price, people more than proportionally buy
less. In the earlier question, we talked about elasticity depending on the alternatives and how easy it was to
switch to them. For this example, it may be a case of people choosing to do without when the price rises.
Preventive health measures reduce disease incidence in the future. That means that not buying it now has no
discernible effect on health immediately, just in the long run. So it is possible to do without. This is different
for example, when you’re sick and need antibiotics or surgery etc. That is much harder to do without.
Paying for the health intervention today means people need to consider the implicit cost of the cash. If they
didn’t use the cash for the health measure, what else could they have spent it on? In a developing country,
having enough cash on hand to pay for the intervention may come at the cost of having cash to pay for
necessities like food etc.
Some studies notice that when people were given cash/loans to buy the health intervention or given time to
raise the funds, they were willing to pay more. You can read more details on this on page 8 of “The Price is
Wrong” J-PAL Bulletin. April 2017. Cambridge, MA: Abdul Latif Jameel Poverty Action Lab.

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