Week 4 Tutorial Questions PDF

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ECO10004: ECONOMIC PRINCIPLES WEEK 4_TUTORIAL QUESTIONS Key concepts: Elasticity, Price Elasticity of Demand, Elastic, Inelastic, Cross-price Elasticity of Demand, Income Elasticity of Demand.

Short-answer Questions Question 1) If a 10 percent increase in the price of Kellogg’s cereal causes a 25 percent reduction in the number of boxes of cereal demanded, what is the price elasticity of demand for Kellogg’s cereal? Is the demand for Kellogg’s cereal elastic or inelastic? -25%/10= -2.5 Elastic, the price elasticity of demand is greater than 1. Question 2) Suppose you own a bookstore. You believe that you can sell 40 copies per day of the latest J.K.Rowling novel (a sequel to the Harry Potter series) when the price is $35. You consider lowering the price to $25 and believe this will increase the quantity sold to 50 books per day a. Using the mid-point formula and based on the data above, calculate the price elasticity of demand for the latest J.K.Rowling novel in your bookstore (10/45)/(-10/30)= -0.67 b. Is the demand for the novel elastic or inelastic? inelastic c. Would you go ahead and reduce the selling price? How will that decision affect your total revenue? Nope, as the demand is inelastic. Reducing the selling price will cause the reduce of total revenue too. Rather we should increase the price, revenue will increase. Question 3) Refer to the lecture slides, list the five key determinants of price elasticity of demand. Explain how each determinant indicates whether demand tends to be elastic or inelastic. Out of those five determinants, which one is the most important? Explain why. 1. Availability of close substitutes: If a product has more substitutes available, it will have more elastic demand. If a product has fewer substitutes available, it will have less elastic demand. This is the most important of the determinants of elasticity of demand. 2. Passage of time: The more time that passes the more elastic the demand for a product becomes. 3. Luxuries versus necessities: The demand curve for a luxury is more elastic than the demand curve for a necessity. 4. Definition of the market: The more narrowly a market is defined, the more elastic demand will be. 5. Share of a good in a consumer's budget: The demand for a good will tend to be more elastic the larger the share of the good in the average consumer's budget. Question 4) For each pair of products below, determine which product would have a higher price elasticity of demand (in absolute value). Refer to the list of determinants in Question 3, point out which determinant is relevant in each case. a. Soft drinks and Coca-Cola. (Definition of the market) b. Drugs for cancer treatment and Louis Vuitton bags . (Luxuries versus necessities) c. Petrol (in the short run) and Petrol (in the long run) . (Passage of time) Page 1|4

d. Petrol and Domino’s Pizza (Availability of close substitutes) e. Salt and cars (Share of a good in a consumer's budget) Pick the following pair of products “Drugs for cancer treatment” and “Louis Vuitton bags”. Draw the demand curve for each of them, then compare. What can you say about the difference in the demand curve between cancer drugs and LV bags? Explain.

Since louis Vuitton is a luxury item, it is elastic, then the value of the price elasticity is greater than 1. As the drugs are necessities, it is inelastic, then the value of the price elasticity is less than 1.

Question 5) Are the cross-price elasticities of demand between the following pairs of products likely to be positive or negative? Briefly explain a. Pepsi and Coca-Cola positive( substitude) b. Fries and tomato sauce Negative(complement) c. Steak and chicken Positive(Substitude) d. Blu-ray players and Blu-ray discs Negative(Complement) Question 6) Rank the following four goods from lowest income elasticity of demand to highest income elasticity of demand. Briefly explain your ranking a. Bread lowest b. Pepsi low c. Mercedes-Benz cars highest d. Personal computers high Question 7) Two drivers – Tom and Jerry – each drive up to a petrol station. Before looking at the price and starting to pump petrol, Tom says: I will buy 10 litres of petrol. Jerry says: I will buy $10 of petrol. Comment on each driver’s price elasticity of demand. Tom: will buy 10litre of petrol; not price sensitive; change in quantity is0. Price elasticity of demand =0. Jerry: will buy 10$ of petrol; %change in quantity=% change in price; unit elasticity.

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Multiple Choice Questions 1. Suppose the value of the price elasticity of demand is -3. What does this mean? a. A 1 per cent increase in the price of the good causes quantity demanded to increase by 3 per cent. b. A 1 per cent increase in the price of the good causes quantity demanded to decrease by 3 per cent. c. A 3 per cent increase in the price of the good causes quantity demanded to decrease by 1 per cent. d. A $1 increase in price causes quantity demanded to fall by 3 units.

2. Refer to the Figure above. Using the midpoint formula, calculate the absolute value of the price elasticity of demand between e and f. a. 0.32 b. 0.4 c. 2.5 d. 3.125 3. Jaycee Jeans sold 40 pairs of jeans at a price of $40. When it lowered its price to $20, the quantity sold increased to 60 pairs. Calculate the absolute value of the price elasticity of demand. Use the midpoint formula. a. 1.67 b. 1.0 c. 0.6 d. 0.53 4. The price elasticity of demand for beef is estimated to be 0.60 (in absolute value). This means that a 20 per cent increase in the price of beef, holding everything else constant, will cause the quantity of beef demanded to a. decrease by 12 per cent. b. decrease by 26 per cent. c. decrease by 32 per cent. d. decrease by 60 per cent. 5. Which of the following statements about the price elasticity of demand is correct? a. The elasticity of demand for a good in general is equal to the elasticity of demand for a specific brand of the good. b. Demand is more elastic in the long run than it is in the short run. c. The absolute value of the elasticity of demand ranges from zero to one. Page 3|4

d. Demand is more elastic the smaller the percentage of the consumer's budget the item takes up.

6. Refer to the Figure above. As price falls from PA to PB, the quantity demanded increases most along D1; therefore, a. D1 is unit elastic. b. D1 is more inelastic than D2 or D3. c. D1 is more elastic than D2 or D3 d. D1 is elastic at PA but inelastic at PB. 7. The price elasticity of demand for Stork ice cream is -4. Suppose you're told that, following a price increase, quantity demanded fell by 10 per cent. What was the percentage change in price that brought about this change in quantity demanded? a. 40 percent b. 25 percent c. 2.5 percent d. 0.4 percent 8. Which of the following goods would usually see the largest decline in demand during a recession? a. Cars b. Food c. Clothing d. Hair cuts 9. Economists estimated that the cross-price elasticity of demand for beer and wine is -0.83 and the income elasticity of wine is 5.03. This means that: a. Beer and wine are substitutes and wine is an inferior good. b. Beer and wine are complements and wine is a luxury good. c. Beer and wine are substitutes and wine is a luxury good. d. Beer and wine are complements and wine is an inferior good. 10. Which of the following goods would have the most inelastic demand? a. Ski vacations b. Bread c. Luxury cars d. Big screen TVs

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