Economics: Markets and Prices (G00A5a)
Exercises 1.5
Chapter 1.5: Elasticities
Exercise 1.5.1
Suppose the demand for coee is given by xD (p) = 600 − 2p, and the supply is given
by xS (p) = 300 + 4p, where p is the price.
1. Solve for the equilibrium price p∗ and quantity x∗ .
2. Calculate the price elasticity of demand and supply at the equilibrium.
Exercise 1.5.1 - Solution
1. Setting demand for coee xD (p) equal to supply xS (p), the market equilibrium
is characterized by
xD (p) = 600 − 2p = 300 + 4p = xS (p) ⇒ p∗ = 50, x∗ = 500. (1)
2. Demand elasticities are usually denoted by ε and de ned by − xp times the
derivative of the demand function w.r.t. own-price p. Supply elasticities are
denoted by η , and are de ned by xp times the derivative of the supply function
w.r.t. own-price p (a derivative which is positive). In our case here, we thus
obtain for the demand side that
p∗ dxD (p∗ ) 50
ε≡− =− (−2) = 0.2, (2)
xD (p∗ ) dp∗ 500
and for the supply side that
p∗ dxS (p∗ ) 50
η≡ ∗ ∗
= 4 = 0.4. (3)
xS (p ) dp 500
1
Exercise 1.5.2
Because of the technological breakthroughs in the fracking industry, the U.S. average
natural gas price has been on a downward path for almost a decade, translating
into lower production costs for electricity producers. With ε the own-price demand
elasticity in the electricity market and η the supply elasticity, the resulting increase
in the quantity of electricity sold in the market will be largest when
1. When ε is small and η is large.
2. When ε is large and η is small.
3. When ε is large and η is large.
4. When ε is small and η is small.
Exercise 1.5.2 - Solution
The third option is correct.
Exercise 1.5.3
Suppose the demand for Tesla coils is given by xD (p) = 11 − 2p, and the supply is
given by xS (p) = −9 + 3p, where p is the price.
1. Solve for the equilibrium price p∗ and quantity x∗ ?
2. Calculate the own-price elasticity of demand and supply at the equilibrium.
3. Given these elasticities, to what degree do you expect supply and demand to
change if the price were to increase by 10 percent?
Exercise 1.5.3 - Solution
1. Setting demand for Tesla coils xD (p) equal to supply xS (p), the market equi-
librium is characterized by
xD (p) = 11 − 2p = −9 + 3p = xD (p) ⇒ p∗ = 4, x∗ = 3. (4)
2. We thus obtain for the demand side that
p∗ dxD (p∗ ) 4
ε=− = − (−2) = 2.67, (5)
xD (p∗ ) dp∗ 3
in equilibrium, and for the supply side that
p∗ dxS (p∗ ) 4
η= = 3 = 4. (6)
xS (p∗ ) dp∗ 3
2
3. Since we know from the supply elasticity that a 1 percent price rise brings
about a 4 percent increase of Tesla coils supplied by the market, a 10 percent
uptick will have supply extend by 40 percent. In a similar vein, and focusing
now on the demand elasticity derived above, a 10 percent price increase results
in a 26.7 percent drop in demand. This is indeed a hyper-charged market.