FIA 104
Principles of Economics
Chapter
3: Elasticity
Practice Questions and Answers
Question 1:
[Link], the online bookseller, wants to increase its total revenue. One strategy is to offer a 10%
discount on every book it sells. [Link] knows that its customers can be divided into two distinct
groups according to their likely responses to the discount. The accompanying table shows how the two
groups respond to the discount.
a. Using the midpoint method, calculate the price elasticities of demand for group A and group B.
b. Explain how the discount will affect total revenue from each group.
c. Suppose [Link] knows which group each customer belongs to when he logs on and can
choose whether or not to offer the 10% discount. If [Link] wants to increase its total revenue,
should discounts be offered to group A or group B, to neither group, or to both groups?
Answer to Question:
a.
Using the midpoint method, the percent change in the quantity demanded by group A is
and since the change in price is 10%, the price elasticity of demand for group A is 6.25%/10%
= 0.625
Using the midpoint method, the percent change in the quantity demanded by group B is
and since the change in price is 10%, the price elasticity of demand for group B is
12.5%/10% = 1.25
b.
For group A, since the price elasticity of demand is 0.625 (demand is inelastic), total revenue
will decrease as a result of the discount. For group B, since the price elasticity of demand is
1.25 (demand is elastic), total revenue will increase as a result of the discount.
c.
If [Link] wants to increase total revenue, it should definitely not offer the discount to
group A and it should definitely offer the discount to group B.
Question 2:
Do you think the price elasticity of demand for Ford sport-utility vehicles (SUVs) will increase,
decrease, or remain the same when each of the following events occurs? Explain your answer.
a. Other car manufacturers, such as General Motors, decide to make and sell SUVs.
b. SUVs produced in foreign countries are banned from the American market.
c. Due to ad campaigns, Americans believe that SUVs are much safer than ordinary passenger cars.
d. The time period over which you measure the elasticity lengthens. During that longer time, new
models such as four-wheel-drive cargo vans appear.
Answer to Question:
a. The price elasticity of demand for Ford SUVs will increase because more substitutes are available.
b. The price elasticity of demand for Ford SUVs will decrease because fewer substitutes are available.
c. The price elasticity of demand for Ford SUVs will decrease because other cars are viewed as less
of a substitute.
d. The price elasticity of demand for Ford SUVs will increase over time because more substitutes
(such as four-wheel-drive cargo vans) become available.
Question 3:
The accompanying table gives part of the supply schedule for personal computers in the United States
a. Calculate the price elasticity of supply when the price increases from $900 to $1,100 using the
midpoint method.
b. Suppose firms produce 1,000 more computers at any given price due to improved technology. As
price increases from $900 to $1,100, is the price elasticity of supply now greater than, less than, or the
same as it was in part a?
c. Suppose a longer time period under consideration means that the quantity supplied at any given
price is 20% higher than the figures given in the table. As price increases from $900 to $1,100, is the
price elasticity of supply now greater than, less than, or the same as it was in part a?
Answer to Question:
a. Using the midpoint method, the percent change in the quantity supplied is
and the percent change in the price is
The price elasticity of supply is therefore 40%/20% = 2
Question 4:
In each of the following cases, do you think the price elasticity of supply is (i) perfectly elastic; (ii)
perfectly inelastic; (iii) elastic, but not perfectly elastic; or (iv) inelastic, but not perfectly inelastic?
Explain using a diagram.
a. An increase in demand this summer for luxury cruises leads to a huge jump in the sales price of a
cabin on the Queen Mary 2.
b. The price of a kilowatt of electricity is the same during periods of high electricity demand as during
periods of low electricity demand.
c. Fewer people want to fly during February than during any other month. The airlines cancel about
10% of their flights as ticket prices fall about 20% during this month.
d. Owners of vacation homes in Maine rent them out during the summer. Due to the soft economy this
year, a 30% decline in the price of a vacation rental leads more than half of homeowners to occupy
their vacation homes themselves during the summer.
Answer to Question:
a. Supply is perfectly inelastic: the quantity of cabins on the Queen Mary 2 is fixed. As demand
increases (a rightward shift in the demand curve), the price of a cabin on the Queen Mary 2 increases,
without an increase in the quantity supplied. See the accompanying diagram
b. Supply is perfectly elastic. As demand changes (for instance, as demand increases in times of high
electricity demand), price does not change but the quantity supplied does change.
c. Supply is inelastic. As price falls by 20%, the quantity supplied falls by 10%. This implies a price
elasticity of supply of
10%/20% = 0.5
which is inelastic. See the accompanying diagram:
d. Supply is elastic. As price falls by 30%, the quantity supplied falls by more than 50%. This implies a
price elasticity of supply greater than
50%/30% = 1.7.
See the accompanying diagram.
