Chapter 4: Review questions - solutions

Multiple Choice Questions:

1. If the demand for sugar does not change at all following a price increase from 50 cents
per kg to 65 cents per kg, the demand for sugar is considered to be
a. inelastic.
b. perfectly elastic.
c. perfectly inelastic.
d. unitary elastic.

If the demand is perfectly price inelastic and the supply is normal. In that case an increase in
the MC (so a shift in the supply curve) will not impact the quantity demanded.

2. If the price of a service decreases and, in percentage terms, quantity demanded rises
more than price has dropped, the providers of this service will see their revenues
a. increase.
b. decrease.
c. remain the same.
d. either increase or decrease.

The Total Revenue = P x Q. In this formula, the P decreases, however, the Q increases more
in percentages. In that case, the quantity effect will dominate and the TR will increase.

3. If the price of beans rises from €1.00 a kg to €2.00 a kg and the quantity demanded
falls from 10 units to 6 units, the elasticity of demand for beans (midpoint method) is:
a. -1.33
b. -0.75
c. -0.4
d. -0.25

Use the arc method to compute price elasticity of demand:

(6 units - 10 units)/10 units = -40% (percentage change in Q)

(2 euro - 1 euro)/1 euro = +100% (percentage change in P)

Take the ratio of the percentage change in Q and the percentage change in P = -0.4

4. In the above example, the demand for beans is:

a. Elastic
b. Inelastic
c. Perfectly elastic
d. Perfectly inelastic

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Price elasticity of demand is in absolute values 0.4 so in the 0-1 range. This implies price
inelastic demand.

5. The cross-price-elasticity of demand for coffee and tea is likely to be:

a. Greater than zero
b. Less than zero
c. Zero
d. Infinity

Coffee and tea are substitutes in consumption. Therefore the cross-price elasticity will be
positive.

6. The cross-price elasticity of demand for coffee and coffee cream is likely to be:
a. Greater than zero
b. Less than zero
c. Zero
d. Infinity

Coffee and coffee cream are complements in consumption. Therefore the cross-price
elasticity will be negative.

Open Questions:

1. Define the price elasticity of demand and the income elasticity of demand.
2. List and explain 4 determinants of the price elasticity of demand.
3. If demand is elastic, how will an increase in price change producer revenue? Explain.
4. What do we call a good whose income elasticity is less than 0?
5. What is the formula for the price elasticity of supply?
6. Is the price elasticity of supply usually larger in the short run or in the long run? Why?

Exercises:

1. Which of the following statements is correct?

a. The cross-elasticity coefficients between personal computers and software is
positive as both products are complements in consumption.
b. The cross-elasticity coefficients between electricity and natural gas is negative
as both products are substitutes in consumption
c. The cross-elasticity coefficients between apples and oranges are positive as
both products are substitutes in consumption.
d. The cross-elasticity coefficients between bread and sun cream is positive as
both products are unrelated.

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 2. Suppose that business travelers and vacationers have the following demand for
airline tickets from Brussels to Geneva:

Price (€) Quantity demanded Quantity demanded

(business travelers) (vacationers)
150 2100 1000
200 2000 800
250 1900 600
300 1800 400

a. As the price of tickets rises from €200 to €250, the price elasticity of
demand for vacationers equals -1.2.
b. As the price of tickets rises from €200 to €250, the price elasticity of
demand for vacationers equals -1.25.
c. As the price of tickets rises from €200 to €250, the price elasticity of
demand for business travelers equals -0.20.
d. As the price of tickets rises from €200 to €250, the price elasticity of
demand for business travelers equals -0.25.

Use the arc method to compute price elasticity of demand:

Business travellers :

(1900 units - 2000 units)/2000 units = -5% (percentage change in Q)

(250 euro - 200 euro)/200 euro = +25% (percentage change in P)

Take the ratio of the percentage change in Q and the percentage change in P: -0.20

Vacationers :

(600 units - 800 units)/800 units = -25% (percentage change in Q)

(250 euro - 200 euro)/200 euro = +25% (percentage change in P)

Take the ratio of the percentage change in Q and the percentage change in P: -1

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 3. Suppose that your demand schedule for CDs is as follows:

Price (€) Quantity demanded Quantity demanded

(income=€10 000) (income=€12 000)
8 40 50
10 32 45
12 24 30
14 16 20
16 8 12

a. The price elasticity of demand as the price of CDs increases from €8 to

€10 if your income is €10 000, equals -1.25.
b. The income elasticity of demand as your income increases from €10
000 to €12 000 if the price is €12, equals 0.8.
c. The price elasticity of demand as the price of CDs increases from €8 to
€10 if your income is €12 000, equals -0.4.
d. The income elasticity of demand as your income increases from €10
000 to €12 000 if the price is €16, equals 0.4.

Use the arc method to compute price elasticity of demand:

When income is 10 000 euro:

(32 units - 40 units)/40 units = -20% (percentage change in Q)

(10 euro - 8 euro)/8 euro = +25% (percentage change in P)

Take the ratio of the percentage change in Q and the percentage change in P: -0.8

When income is 20 000 euro:

(45 units - 50 units)/50 units = -10% (percentage change in Q)

(10 euro - 8 euro)/8 euro = +25% (percentage change in P)

Take the ratio of the percentage change in Q and the percentage change in P: -0.4

Use the arc method to compute income elasticity of demand:

When p = 12 euro:

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(30 units - 24 units)/24 units = +25% (percentage change in Q)

(12 000 euro – 10 000 euro)/10 000 euro = +20% (percentage change in income)

Take the ratio of the percentage change in Q and the percentage change in income: +1.25

When p = 16 euro:

(12 units - 8 units)/8 units = +50% (percentage change in Q)

(12 000 euro – 10 000 euro)/9 000 euro = +20% (percentage change in income)

Take the ratio of the percentage change in Q and the percentage change in income: +2.5

4. Which of the statement is correct?

a. Studies indicate that the price elasticity of demand for cigarettes is -0.4. If a
pack of cigarettes currently costs €2 and the government wants to reduce
smoking by 20%, the price of a pack of cigarettes should increase from 2 to
2.5 euro.

price elasticity of demand for cigarettes is -0.4. This means that if the price of cigarettes
increases by 10%, the demand decreases by 4%. So if you want the quantity to decrease with
20%, the price should increase by 50%. The price should thus increase from 2 euro to 3 euro.

b. If the government permanently increases the price of cigarettes, the policy

will have a larger effect on smoking one year from now as compared to five
years from now.

Yes, people have a longer time horizon to look for alternatives (viping, quiting with smoking,
etc.)

c. With regard to smoking teenagers have a higher price elasticity than adults as
the expenditure of a pack of cigarettes represents a lower budget share in
their income.

Teenagers have a lower budget. So the price of cigarettes is a larger part of the teenagers’
budget. This explains for the larger price elasticity.

d. None of the above.

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5. Pharmaceutical drugs have an inelastic demand and computers have an elastic
demand. Suppose that a technological advance doubles the supply of both products
(the quantity supplied at each price is twice what it was).

a. The equilibrium price will increase and the equilibrium quantity will decrease
in each market.
b. The equilibrium price will change the most in the market for pharmaceutical
drugs.
c. The equilibrium quantity will change the most in the market for
pharmaceutical drugs.
d. The TR will decrease for computers, will increase for pharmaceutical drugs.

Sketch the two situations:

Pharmaceutical drugs:
QD
p
Qs Q’s

E’

Computers:
p
Qs Q’s

QD

E’

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 6. Seafront properties along the promenade at Brighton on the south coast of England
have an inelastic supply, and cars have an elastic supply. Suppose that a rise in
population doubles the demand for both products (the quantity demanded at each
price is twice what it was).
a. The equilibrium price will decrease and the equilibrium quantity will increase
in each market.
b. The market for seafront properties experiences a smaller change in price.
c. The market for cars experiences a smaller change in quantity.
d. The TR will increase in both markets.

Seafront properties along the promenade at Brighton on the south coast of England:

p
Q’D Qs
QD
E’

Cars:

p
Q’D
QD Qs
E’

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 7. Market research has revealed the following information about the market for
chocolate (Q is measured in kg): Q d = 70 – 3P and Qs= -10 + 5P. Which of the following
statements is false?
a. The equilibrium price in the market for chocolate equals 10.
b. The equilibrium quantity in the market for chocolate equal 40.
c. The point price elasticity of demand in the market equilibrium equals -0.75.
d. The point price elasticity of supply in the market equilibrium equals 0.8.

In the market equilibrium it holds that QD = QS

70 - 3P = -10 + 5P

Thus: 80 = 8p → P* = 10

Fill in P*=10 in either QS or QD, this yields Q* = 40.

d
dQ P 10
εQ ,P =
d p =¿-3* =−0.75
dP Q 40

If the price rises by 10%, the demand will decrease by 7,5%

s
dQ P 10
εQ ,P =
s s =¿+5* =+1.25
dP Q 40

If the price rises by 10%, the supply will increase by 12.25%

8. The demand and supply curve for the market of golf balls (golf balls are sold in
packets of 20) are respectively Q d = 90 – 2P – 2T and Q s= -9 +5P - 2.5R with P the
price of golf balls, T the price of titanium (metal that is used in the production of golf
clubs) and R the price of rubber. Suppose R = 2 and T = 10. Which of the following
statements is false:
a. The equilibrium price and quantity in the market for golf balls is respectively
P=12 and Q=46.
b. The price elasticity of demand in the market equilibrium equals -0.52.
c. The price elasticity of supply in the market equilibrium equals 1.3.
d. The cross-price elasticity for the demand for golf balls according to the price
of titanium in the market equilibrium equals 2.3.

Qd = 90 – 2P – (2x10) = 70-2P

Qs= -9 +5P – (2.5x2) = -4 + 5P

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In the market equilibrium it holds that QD = QS

70 - 2P = -14 + 5P

Thus: 84 = 7p → P* = 12

Fill in P*=12 in either QS or QD, this yields Q* = 46.

d
dQ P 12
εQ ,P =
d p =¿-2* =−0.52
dP Q 46

If the price rises by 10%, the demand will decrease by 5.2%

s
dQ P 12
εQ ,P =
s s =¿+5* =+1.30
dP Q 46

If the price rises by 10%, the supply will increase by 13%

Fill in the price of P = 12:

Qd = 90 – (2x12) – 2T = 66 – 2T

D
dQ
Q d Qd T 10
εQ D T = = =¿+2* =+ 0.43
,P
dT dT Q 46
T

If the price of titanium increases by 10%, the demand of golf balls will increase by 4.3%

9. Demand for pizza in the United States is represented as follows:

Qd = 200 – 0.5Pp – 0.25Pb + 50 D + 0.01 I
with Pp the average price of a pizza (in dollar), Pb the average price of a six-pack of
beer (in dollar), D a variable that is 1 during the soccer season and 0 outside the
soccer season, I the average yearly available income of a consumer. Suppose that
Pp = $8, Pb = $4, D=1 and I = $10 000. Which of the following statements is false:

a. The price elasticity of the demand for pizza when equals -0.012.

In the given point Q=200-0.5*8-0.25*4+50*1+0.01*10 000 = 345

d p
dQ P 8
εQ ,P =
d p =¿-0.5* =−0,012
p
dP Q 345

If the price of pizza rises by 10%, the demand will decrease by 0.12%

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 b. The cross-price elasticity of the demand for pizza with respect to the price of
beer equals -0.003.
d
d Q p Pb 4
εQ ,P =
d b
b d
=¿-0.25* =−0.003
p
d P Qp 345

If the price of beer rises by 10%, the demand for pizza will decrease by 0.03%
(complementary goods but the impact is very small)

c. The income elasticity of the demand for pizza equals 0.29.

d
dQ I 10 000
ε Q , I=
d =0 , 01* =¿0.29
dI Q d
345

It the income rises by 10%, the demand for pizza will rise by 2,9% (pizza is a normal good)

d. All of the above statements are false.

10. In Mexico City, the price for a trip on the local subway has been 10 pesos for several
years. Suppose that the market for trips is characterized by the following weekly
demand curves: in the long run: Q = 30 – 2P; in the short run: Q = 15 – P/2 (where Q
is measured in 1000nd of trips). Which of the following statements is false.
a. Price elasticity in the long run market equilibrium is -2.
b. Price elasticity in the short run market equilibrium is -0.5.
c. The consumer is more price sensitive in the long run compared to the short
run as in the short run it is more easy to look for an alternative.
d. The consumer is more price sensitive in the long run compared to the short
run as in the short run it is it is less easy to change your means of transport.

Price elasticity in the long run:

d
dQ P 10
ε Q , P=
d =¿-2* =−2
dP Q 10

If the price of a trip increases by 1%, the demand in the long run decreases by 2%
Price elasticity in the short run:
d
dQ P 10
ε Q , P=
d =¿-0.5* =−0.5
dP Q 10

If the price of a trip increases by 1%, the demand in the short run decreases by 0.5%

The consumer is more price sensitive in the long run compared to the short run.
Therefore the long-run demand curve will be flatter.

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 In the long-run a consumer can more easily look for an alternative. E.g. when the
subway becomes too expensive, the consumer can choose to buy a bike or a car in
the long run. In the short run it is less easy to change your means of transport.

11. Given:
d −1 e
Q = P+10 ; Q =5 ; price elasticity of supply=1
4
Determine the equation of the linear supply curve.

Linear supply curve: QS = a + bP

d QS P
ϵQ P = . =1
S,
dP QS

P
ϵQ P =b. =1 (b is the slope of the demand curve)
S,
QS

−1
Qe = 5 → 5 = P+10 in the equilibrium the price is therefore : Pe = 20
4

20
In the equilibrium: ϵ Q P =b. =1 therefore b=1/4
S,
5

1
We now know: QS = a + P
4

1
To find a, we fill in the point (20; 5) in the equation: 5 = a + *20 therefore a=0
4

1
The supply equation: Qs= P
4

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