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Managerial Economics, 7e (Keat) Chapter 4 Demand Elasticity (Appendix 4A) Multiple-Choice Questions 1) The price elasticity of demand is a measure of A) the responsiveness of the quantity demanded to price changes. B) the quantity demanded at a given price. C) the shift in the demand curve when price changes. D) the demand for a product holding price constant. Answer: A Diff: 1 2) The elasticity of demand for a product is likely to be greater A) the smaller the number of substitute products available. B) the smaller the proportion of one's income spent on the product. C) the larger the number of substitute products available. D) if the product is an imported good rather than a domestically produced good. Answer: C Diff: 2 3) If OPEC increases its price of oil, and still the demand for oil decreases by a very small amount, we can conclude that the demand for oil is A) relatively elastic. B) relatively inelastic. C) perfectly elastic. D) perfectly inelastic. Answer: B Diff: 1 4) If the consumption of sugar does not change at all following a price increase from 50 cents per pound to 65 cents per pound, the demand for sugar is considered to be A) relatively inelastic. B) perfectly elastic. C) perfectly inelastic. D) unitary elastic. Answer: C Diff: 1 5) If the demand for a product is said to be relatively inelastic, the "absolute" value of the elasticity coefficient will be A) less than one. B) greater than one. C) equal to one. D) zero. Answer: A Diff: 1 1 Copyright © 2014 Pearson Education, Inc.

6) If an item has several good substitutes, the demand curve for that item is likely to be A) relatively inelastic. B) relatively elastic. C) perfectly inelastic. D) unit elastic. Answer: B Diff: 1 7) Remembering that demand elasticity is defined as the percentage change in quantity divided by the percentage change in price, if price decreases and, in percentage terms, quantity rises more than price has dropped, total revenue will A) increase. B) decrease. C) remain the same. D) either increase or decrease. Answer: A Diff: 3 8) Suppose the price of beans rises from $1.00 a pound to $2.00 a pound, quantity demanded falls from 10 units to 6 units, the coefficient of elasticity of demand for beans using the arc elasticity approach is A) -1.33. B) -0.75. C) -0.4. D) -0.25. Answer: B Diff: 3 9) Suppose the price of beans rises from $1.00 a pound to $2.00 a pound, quantity demanded falls from 10 units to 6 units. In this example, the demand for beans is said to be A) relatively elastic. B) relatively inelastic. C) perfectly elastic. D) perfectly inelastic. Answer: B Diff: 2 10) A perfectly elastic demand curve A) can be represented by a line parallel to the vertical axis. B) is a 45-degree line. C) can be represented by a line parallel to the horizontal axis. D) cannot be represented on a two-dimensional graph. Answer: C Diff: 1

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11) The sensitivity of the change in quantity consumed of one good to a change in the price of a related good is called A) cross-elasticity. B) substitute elasticity. C) complementary elasticity. D) price elasticity of demand. Answer: A Diff: 1 12) 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. Answer: A Diff: 2 13) 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. Answer: B Diff: 2 14) The cross-price elasticity of demand for coffee and caskets is likely to be A) less than zero. B) greater than zero. C) zero. D) infinity. Answer: C Diff: 1 15) When purchases of tennis socks decline following an increase in the price of tennis sneakers (other things remaining equal), the relationship between these two items can be described as A) substitutable. B) complementary. C) unique. D) ordinary. Answer: B Diff: 2

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16) The owner of a produce store found that when the price of a head of lettuce was raised from 50 cents to $1, the quantity sold per hour fell from 18 to 8. The arc elasticity of demand for lettuce is A) -0.56. B) -1.15. C) -0.8. D) -1.57. Answer: B Diff: 3 17) Suppose the price of crude oil drops from $150 a barrel to $120 a barrel. The quantity bought remains unchanged at 100 barrels. The coefficient of price elasticity of demand in this example would be A) -0.5. B) infinity. C) -1.0. D) 0. Answer: D Diff: 2 18) If a firm decreases the price of a good and total revenue decreases, then A) the demand for this good is price elastic. B) the demand for this good is price inelastic. C) the cross elasticity is negative. D) the income elasticity is less than 1. Answer: B Diff: 2 19) When total revenue reaches its peak (elasticity equals 1), marginal revenue reaches A) 1. B) zero. C) -1. D) Cannot be determined from the information provided Answer: B Diff: 3

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20) If the income elasticity of a particular good is negative 0.2, it would be considered A) a superior good. B) a normal good. C) an inferior good. D) an elastic good. Answer: C Diff: 1 Table 1 The following information is provided for Tony Romo's income and expenditures. Quantity Purchased per Month Monthly Income Steaks Pizzas $2,000 2 8 $3,000 4 6 21) In Table 1, Tony's income elasticity of demand for steaks is A) 1.0. B) greater than 1.0. C) less than 1.0. D) zero. Answer: B Diff: 3 22) In Table 1, pizzas are classified as a(n) A) normal good. B) positive good. C) inferior goods. D) marginal good. Answer: C Diff: 2 23) In Table 1, steaks are classified as a(n) A) normal good. B) positive good. C) inferior good. D) marginal good. Answer: A Diff: 2 24) In Table 1, Tony's income elasticity of demand for pizzas is A) 0. B) less than zero. C) greater than 1.0. D) 1.0. Answer: C Diff: 3 5 Copyright © 2014 Pearson Education, Inc.

25) The government unit that wants to achieve "revenue enhancement" will find it considerably more favorable to enact an excise tax on goods whose demand is A) highly elastic. B) relatively elastic. C) highly inelastic. D) unitary elastic. Answer: C Diff: 3 26) Which of the following instances will total revenue or receipts decline? A) Price rises and demand is inelastic. B) Price falls and demand is elastic. C) Price rises and demand is elastic. D) Price falls and demand is unit elastic. Answer: C Diff: 2 27) If the price of a good is increased and total revenue received from the sale of this good increases, then the price elasticity of demand for the good is A) elastic. B) inelastic. C) unitary. D) None of the above Answer: B Diff: 2 28) If the price of a good is decreased and total revenue received from the sale of this good does not change, then the price elasticity of demand for the good is A) elastic. B) inelastic. C) unitary. D) None of the above Answer: C Diff: 2 29) If the demand for a good is price inelastic and the good price is increased, then the marginal revenue (MR) received by the seller will A) not change. B) decrease. C) increase. D) Cannot be determined from this information Answer: C Diff: 3

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30) If the price elasticity of supply of a good is elastic and the good price increases, then the increase in the good's supply should be A) greater than the increase in price. B) less than the increase in price. C) the same as the increase in price. D) Cannot be determined from this information Answer: A Diff: 3 31) Which of the following examples best illustrates the concept of derived demand? A) An increase in the price of beef results in an increase in the demand for fish. B) The higher the demand for automobiles, the greater the demand for steel. C) The demand for Pepsi varies directly with the price of Coke. D) The demand for a good varies inversely with its price. Answer: B Diff: 2 32) The derived demand curve for a good component will be more inelastic A) the larger is the fraction of total cost going to this component. B) the more inelastic is the demand curve for the final good. C) the more elastic are the supply curves of cooperating factors. D) the less essential is the component in question. Answer: B Diff: 3 33) The minimum wage is an example of a government imposed A) price control. B) price ceiling. C) price floor. D) Both A and B E) Both A and C Answer: E Diff: 2 34) If government imposes a price ceiling on a good that is below the market equilibrium price A) a surplus will develop. B) a shortage will develop. C) producers will reduce their sales price. D) consumers will reduce their demand for the good. Answer: B Diff: 2

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35) When a government imposes a price floor on a good that is above the market equilibrium price A) a surplus will develop. B) a shortage will develop. C) producers will increase their sales price. D) consumers will increase their demand for the good. Answer: A Diff: 2 36) A tax that is imposed as a specific amount per unit of a good is a(n) A) excise or specific tax. B) sales or ad valorem tax. C) compound duty. D) income tax. Answer: A Diff: 1 37) If government imposes an excise tax on a good and the tax burden is borne equally by buyers and sellers, then A) price elasticity of demand is unitary. B) price elasticity of supply is unitary. C) the absolute values of price elasticities of demand and supply are equal. D) None of the above Answer: C Diff: 2 38) Assuming mustard and burgers are complements, a decline in the price of burgers will A) decrease the demand for burgers. B) decrease in the quantity demanded of burgers. C) increase the demand for mustard. D) decrease the demand for mustard. Answer: C Diff: 2 39) Other things remaining the same, an increase in the price of butter can be expected to A) increase margarine sales. B) decrease margarine sales. C) increase butter sales. D) None of the above Answer: A Diff: 2

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Analytical Questions 1) The initial price of a cup of coffee is $1, and at that price, 400 cups are demanded. If the price falls to $0.90, the quantity demanded will increase to 500. a. Calculate the (arc) price elasticity of demand for coffee. b. Based on your answer, is the demand for coffee elastic or inelastic? c. Based on your answer to a., if the price of coffee is increased by 10%, what will happen to the revenues from coffee? Carefully explain how you know. Answer: a. Arc elasticity = -2.11 b. Elastic c. Revenues will fall. Demand is elastic, and thus a 1% increase in price will lead to a greater percentage decrease in quantity demanded. Revenues fall because the price increase does not make up for the reduction in sales. 2) The demand curve is: QD = 500 - 1/2 P. a. Calculate the (point) price elasticity of demand when price is $100. Is demand elastic or inelastic? b. Calculate the (point) price elasticity of demand when price is $700. Is demand elastic or inelastic? c. Find the point at which point elasticity is equal to -1. Answer: a. Elasticity = -1/2 (100/450) = -0.11, and is inelastic. b. Elasticity = -1/2(700/150) = -2.5, and is elastic. c. Elasticity is -1 at the midpoint of the demand curve, which is at a price of $500 and a quantity of 250. 3) Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a good wheat crop (which increases the supply of wheat) be likely to increase or decrease the revenues of farmers? Carefully explain. Answer: A good wheat crop that increases the supply of wheat will cause the equilibrium price of wheat to decrease (and quantity to increase). Since demand is inelastic, total revenues will fall, as the percentage change in quantity will be less than the percentage change in price. 4) The demand for salt is relatively price inelastic, while the demand for pretzels is relatively price elastic. How can you best explain why? Answer: Salt has few substitutes, and takes up a small percentage of the consumer's budget, and thus demand is likely to be inelastic. While pretzels are also a small part of the budget, there are many substitutes available.

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5) Unions have generally been far more successful in organizing and raising wages in skilled trades such as carpentry than in unskilled trades. Use the laws of derived demand to explain why. Answer: There are at least two reasons. One is that the elasticity of substitution between skilled workers and other factors of production is low; thus firms cannot substitute some other factor of production if wages rise. Secondly, skilled labor is likely to be a relatively small percentage of total costs, and thus raising wages does not cause a large increase in total costs (which would lead to a reduction in supply, an increase in price, and a decrease in output). Unskilled labor has more substitutes and is likely to be a larger share of costs for firms that employ it, and thus if unions raise wages, firms employ other factors of production, and many workers will be laid off. 6) Governments impose excise taxes on goods that have inelastic demand, such as cigarettes, more often than in other cases. Why? Answer: Imposing an excise tax reduces the supply of the good, reducing equilibrium quantity and raising the price. If demand is elastic, taxes will tend to reduce quantity by a significant amount, and thus government tax revenues will be relatively small. However, if demand is inelastic, the reduction in quantity will be small, and government tax revenues will be higher. (Governments may also impose taxes to deter consumption, but this is likely to be ineffective if elasticity is low.) 7) Demand and supply in the wheat market are given by: QD = 2000 - 1000 P and QS = -500 + 1000 P where Q is millions of bushels and P is price per bushel. a. Find the equilibrium price and quantity. b. Suppose that the government wishes to support farm income and thus sets a price floor of $1.50/bushel. Find the size of the farm surplus. c. What is the cost of this program to the government? Answer: a. P = $1.25, Q = 750 b. If P = $1.50, QD = 500 and QS = 1000. The surplus is 500 (million) bushels. c. $1.50 × 500 = $750 million.

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8) Demand is given by QD = 6000 - 50P. Domestic supply is QS = 25P. Foreign producers can supply any quantity at a price of $40. a. If foreign producers can sell in the domestic market, what is the equilibrium price? What is the equilibrium quantity? How much is sold by domestic and foreign producers, respectively? b. Under domestic government pressure, foreign producers voluntarily agree to restrict their goods. What will happen to the price and quantity? What will happen to the amount that domestic producers supply? What will happen to revenues of domestic and foreign producers? Answer: a. P = $40. Q = 4,000. Of that, domestic producers supply 1,000 units, and foreign producers supply 3,000 units. b. The quantity restriction will cause equilibrium price to rise and quantity to decrease. Domestic producers will sell more, and foreign producers will sell less. Revenues of domestic producers will rise. The effect on the revenues of foreign producers is unclear; if demand is inelastic, they may rise. 9) You are told that the price elasticity of demand for widgets is -0.75, the income elasticity of widgets is 2, and the cross-price elasticity of widgets and gadgets is 4. Carefully explain what information you can gather from each of these figures. Answer: Demand for this good is inelastic with respect to price. This is a normal good as income elasticity is greater than zero, and it is a luxury/superior good as income elasticity is greater than one. Widgets and gadgets are substitutes, and they are good substitutes because cross-price elasticity is elastic (large). 10) If a good's demand function is Q = 30 - 3P, then calculate the price elasticity of demand when a. good price is $3 using the point elasticity formula b. good price is $4 using the point elasticity formula c. good price decreases from $4 to $3, using the arc elasticity formula d. good price is $5, using the point elasticity formula e. good price increases from $4 to $5, using the arc elasticity formula Answer: (a) -0.429; (b) -0.667; (c) -0.538; (d) -1.000; (e) -0.818 11) If a price of corn is $3.00 a bushel, 5,000 bushels would be demanded. If the price rises to $4.00 a bushel, 4,000 bushels would be demanded. a. What is the (arc) price elasticity of demand? b. Based on this answer, if the price of corn rose to $5.00 a bushel, what would be the demand for corn? c. If the price of corn decreased from $4.00 to $3.00 a bushel, what would be the change in total revenue for sellers of corn? d. If the price of corn increased from $4.00 to $5.00 a bushel, what would be the change in total revenue for sellers of corn? Answer: (a) -0.778; (b) 3,309; (c) -$1,000; (d) +$545

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12) Domestic demand for a good is QD = 3000 - 25P. The domestic supply of the good is QS = 20P. Foreign producers can supply any quantity at a price (P) of $30. a. What is the domestic equilibrium price and quantity? b. At this domestic equilibrium price, how much of the good will be supplied by domestic producers and how much by foreign producers? Answer: a. P = $30 and Q = 2250 b. Domestic producers supply 600 units and foreign producers supply 1650 units. 13) The income elasticity for most staple foods, such as wheat, is known to be between zero and one. a. As incomes rise over time, what will happen to the demand for wheat? b. What will happen to the quantity of wheat purchased by consumers? c. What will happen to the percentage of their budgets that consumers spend on wheat? d. All other things equal, are farmers likely to be relatively better off or relatively worse off in periods of rising incomes? Answer: a. Demand will increase, since wheat has a positive income elasticity. b. The quantity of wheat purchased will increase. c. The percentage of consumer budgets spent on wheat and other staple goods will fall, since the percentage change in the demand for wheat will be less than the percentage change in income. d. Farmers are likely to be relatively worse off, since the demand for what they are selling will be rising less rapidly than the demand for other goods that they are likely to purchase.

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