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# Elasticity of Demand & Supply

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• 1. Multiple Choice Tutorial Chapter 5 Elasticity of Demand & Supply
• 2. 1. In market economies, most production and consumption decisions are guided by a. government decree b. foreign countries (imports and exports) c. monopolists’ desires to maximize profits d. individual choice under the price systemD. A business will only sell what consumers want to buy. 2
• 3. 2. In general, “elasticity” can measure a. whether a price increase causes quantity demanded to increase or decrease b. the strength of an economy’s tendency to recover from recession c. the responsiveness of decision makers to economic changes in pricesC. You can think of elasticity as a rubber band. Elastic means it can stretch, the easier it stretches the more elastic the rubber band. When price changes for a good and the quantity demanded changes a lot, the demand curve is very elastic. When price changes and the quantity demanded changes a little, the demand curve is inelastic. 3
• 4. 3. More “elastic” means a. less desirable b. less desirable c. less responsive d. more responsiveD. For example, in a perfectly competitive market, if a firm (let’s say a farmer) charges a price higher than the market price its sales will drop to zero. Why would anyone buy from a higher priced firm if they can buy exactly the same thing from a multitude of other firms? In this case the responsiveness is absolute, the demand curve is perfectly elastic. 4
• 5. 4. Price elasticity of demand is calculated as a. the percentage change in quantity demanded divided by the percentage change in price b. the percentage change in price divided by the percentage change in quantity demanded c. the absolute change in quantity demanded divided by the absolute change in price A. A percent change is measured by the difference between the two numbers divided by the original number. For example, what is the percent increase from 3 to 5 units? 2 divided by 3. What is the percent decrease from 5 to 3? 2 divided by 5. 5
• 6. 5. Without making an adjustment such as finding the absolute values of the percentage changes, the price elasticity of demand would be negative because a. price and demand are directly related b. price and demand are inversely related c. price and quantity demanded are inversely relatedC. As the price of a good increases, the quantity demanded decreases and vice versa. This may not always be true, but in this course we assume that it is always true. Because the relationship is always negative, we normally concentrate on the absolute values of numbers. 6
• 7. 6. In calculating price elasticity of demand, we use average price and average quantity as our base value because a. it reduces the complexity of the formula and makes the calculation easier b. the resulting measure is then not influenced by whether price is rising or falling c. we would get the same answer if we use the initial price and quantityB. Instead of measuring elasticity as the difference between two numbers divided by the original number, we take the difference between the two numbers divided by the average of the two numbers. 7
• 8. 7. Price elasticity of demand is not influenced by a. the number of substitutes available b. the proportion of the consumer’s budget spent on the good c. the length of the time period under consideration d. the units of measurement used for price or for quantity demanded D. Whether we are dealing in American dollars or European Euros or whether we are dealing with cars or shoes, the formula for measuring elasticity is the same. 8
• 9. 8. Edith buys 9 magazines per week when the price is \$3. She buys 11 magazines per week when their price is \$2. Edith’s price elasticity of demand is a. -1/2 = -0.5 b. -2/3 = -0.667 c. -1.0 A. The difference between 9 and 11 units is 2 and the average quantity is 10. The difference between \$3 and \$2 is 1 and the average price is 2.5. 2/10 / 1/2.5 = 2/10 x 2.5/1 = 5/10 = 1/2 = .5. * most authors drop the negative sign, McEachern does not in his book. 9
• 10. 9. Matt bought 6 CDs last month, when the price was \$14. This month, when the price of CDs increased to \$16, Matt bought only 4 CDs. Matt’s price elasticity of demand is a. -1/3 = -0.333 b. -3/7 = -0.429 c. -7/3 = -2.333 d. -3D. The difference between the quantities demanded is 2 and the average quantity is 5. The difference between the prices is 2 and the average price is 15. So:2/5 divided by 2/15 = 2/5 x 15/2 = 30/10 = 3* Again, McEachern uses the negative sign. 10
• 11. 10. If a 5% increase in price leads to an 8% decrease in quantity demanded, demand is a. perfectly elastic b. elastic c. unit elastic d. inelasticB. When price increases and a sellers total revenue increases, the demand is inelastic. When the price increases and the sellers total revenue decreases, the demand is elastic. In this case total revenue will decrease because the quantity demanded is decreasing at a greater percentage than the increase in price. 11
• 12. 11. If price elasticity of demand is -0.5, a. a 1% decrease in quantity demanded leads to a 0.5% decrease in price b. a 1% decrease in price leads to a 0.5% increase in quantity demanded c. a 50% decrease in price leads to a 1% increase in quantity demanded d. demand is elasticB. The percent change in quantity divided by the percent change in price is equal to the price elasticity of demand. So in this case, the percent change in quantity is equal to .5 and the percent change in price is 1, so .5 / 1 = .5 12
• 13. 12. Unit elastic demand occurs when a. a one-unit increase in price leads to a one- unit decrease in quantity demanded b. a 1% increase in price leads to a one-unit decrease in quantity demanded c. price elasticity of demand is positive d. price elasticity of demand is exactly -1D. The price elasticity of demand is unitary elastic when the percent change in quantity demanded divided by the percent change in price is equal to one. 13
• 14. 13. Knowledge of price elasticity of demand a. is of no use to producers b. tells producers what will happen to total profit if they change product price c. tells producers what will happen to quantity supplied if they change product price d. tells producers what will happen to total revenue if they change product price D. Let’s say you own a business. Should you raise your price? What will happen to your total revenue if you do so? If you know the price elasticity of demand for your product you will know the answer before the fact. 14
• 15. 14. In calculating price elasticity of demand, which of the following is assumed to be held constant? a. the price of the product itself b. the quantity demanded of the product c. total revenue received from the sale of the product d. the prices of all other productsD. Anytime we change something and want to know the result we always assume that everything else stays the same. The Latin term for this assumption is ceteris paribus. 15
• 16. 15. Total revenue is defined as a. the net profit after the opportunity cost of all resources used has been deducted b. the change in quantity sold divided by the change in price c. price elasticity of demand times quantity sold d. price times quantity soldD. If you own a business and the price for your product is \$2 and you sell 3 units, your total revenue is \$6. 16
• 17. 16. If a firm raises the price of its product, its total revenue will a. always increase b. increase only if demand is price inelastic c. increase only if demand is price elastic d. remain constant, regardless of price elasticity of demandB. In this case total revenue increases because the percent change in quantity sold is more than the percent change in price. 17
• 18. 17. If a price reduction leads to greater total revenue, demand is a. perfectly inelastic b. inelastic c. unit elastic d. elasticD. In this example price is decreasing instead of increasing. If a firm lowers its price and its total revenue increases as a result, this means that the percent change in quantity demanded is greater than the percent change in the price. Because the quantity demanded is changing more than the change in price, the demand curve is elastic. 18
• 19. 18. John spends exactly the same dollar amount of candy bars each week, regardless of their price. John’s demand curve for candy bars is a. upward-sloping b. backward-bending c. perfectly inelastic d. unit elasticC. A perfectly inelastic demand curve is perfectly vertical. This means that a change in price has no effect on the quantity demanded. 19
• 20. 19. When demand is price inelastic, total revenue is a. directly related to quantity demanded b. inversely related to quantity demanded c. directly related to price d. not related to either price or quantity demandedA. A direct relationship means that when there is a change in one variable the other variable changes in the same direction. For example, if one goes up the other will increase as well. In this case, an increase in price leads to an increase in total revenue, which is the definition of an inelastic demand curve. 20
• 21. 20. Along a linear, downward-sloping demand curve, price elasticity of demand a. is impossible to calculate b. is constant and is equal to the slope c. is constant and is equal to the inverse of the slope d. becomes more elastic as price increasesD. Linear means a straight line. Consumers will have a greater response to a change in price at higher prices than they will at lower prices. 21
• 22. 21. A linear, downward-sloping demand curve has a. constant slope and constant elasticity b. constant slope and varying elasticity c. varying slope and constant elasticity d. varying slope and varying elasticityB. The slope all along a straight line is the same. This is what makes a straight line a straight line. Elasticity along this straight line demand curve varies. The reason is the same as explained in question 20. 22
• 23. 22. When the demand curve is linear with the typical downward slope, a firm can receive the greatest total revenue by a. charging the highest price possible b. selling the most output possible c. producing where demand is inelastic d. producing where demand is unit elasticD. A profit maximizing firm will continue to raise its price if the higher price leads to an increase in revenue, ceteris paribus. So at what point will it stop raising its price? At the point where the percent change in quantity is equal to the percent change in price. 23
• 24. 23. A perfectly elastic demand curve is a. a vertical straight line b. a horizontal straight line c. a downward-sloping straight line d. an upward-sloping straight lineB. A perfectly horizontal demand curve shows that any increase in price beyond the price at which the demand curve is at will lead to zero sales. 24
• 25. 24. If a firm whose product faces a perfectly elastic demand curve raises its price, a. it will sell exactly the same amount of output as it did at the lower price b. it will lose some, but not all, of its sales c. its sales will decrease to zero d. its sales will increaseC. This is the case for a farmer who is a part of a perfectly competitive industry. Because there are so many farmers at the market selling identical products they become price takers; they must take whatever price the market determines. Any price above this price will result in zero sales. 25
• 26. 25. A perfectly inelastic demand curve is a. a vertical straight line b. a horizontal straight line c. a downward-sloping straight line d. an upward-sloping straight line A. The vertical line is at the quantity that will be demanded regardless of the product’s price. 26
• 27. 26. If a firm facing a perfectly inelastic demand curve raises its price, a. it will still sell exactly the same amount of output as it did at the lower price b. it will lose some, but not all, of its sales c. its sales will decrease to zero d. its sales will increaseA. In this case, a change in price has no effect on the quantity demanded. 27
• 28. 27. The more broadly a good is defined a. the more substitutes it has, so its demand will be more elastic b. the less substitutes it has, so its demand will be more elastic c. the more substitutes it has, so its demand will be less elastic d. the less substitutes it has, so its demand will be less elasticD. Ease of substitution is a variable that determines a product’s elasticity. The easier the substitution, the more elastic the demand curve. The more broadly defined the good, the more difficult it is to find substitutes. 28
• 29. 28. Which of the following effects a product’s price elasticity of demand? a. ease or difficulty of substitution b. the time factor c. how much of a necessity the product is to consumers d. all of the aboveD. The easier the substitution, the more elastic the demand curve. The more time consumers have to respond to a price change, the more elastic the demand curve. The less the product in question is a necessity, the more elastic is the demand curve it faces in the market. 29
• 30. 29. Which of the following is likely to have the most elastic demand? a. beef steak b. beef (including steak, ribs, burgers, etc.) c. meat (including beef, pork, chicken, etc.) d. protein foods (including meat, cheese, eggs, etc.)A. The more broad the market the less elastic is the demand curve. Beef steak is a market that is much less broad than beef, meat, and protein foods. 30
• 31. 30. Advertising is related to price elasticity of demand a. in no way whatsoever b. in that producers try to convince consumers that their particular product is a close substitute for virtually all other products in the industry c. in that producers try to convince consumers that their particular product is unique, with no close substitutesC. Price elasticity of demand is a measure of consumer’s responsiveness to a change in a product’s price in the market. Advertising can influence consumer’s responsiveness. 31
• 32. 31. Other things being equal, the price elasticity of demand for a product will be more elastic a. if spending on the item is a very large proportion of the household’s budget b. if spending on the item is a very small proportion of the household’s budget c. when the price of the product is very low d. for a product with no close substitutesA. The larger the price of a product is to a consumer’s budget the more elastic is the demand curve. For example, a ten percent change in the price of a new car will have more of an impact on decision making than a ten percent change in the price of a box of salt. 32
• 33. 32. Price elasticity of demand and price elasticity of supply are both influenced by a. the availability of close substitutes for the product b. the proportion of the consumer’s budget spent on the product c. the length of the adjustment period consideredC. In the early 1970’s OPEC greatly increased the price of their oil. Because oil is a necessity with few substitutes, we had no choice but to pay the higher price. However, in time the western world developed substitutes, found alternative sources of oil, and took action that led to a decline in demand for 33 imported oil.
• 34. 33. Price elasticity of supply is calculated as a. the unit change in quantity supplied caused by a \$1 change in price b. the percent change in quantity supplied caused by a 1% change in price c. the dollar change in price caused by a one- unit change in quantity supplied d. the percent change in price caused by a 1% change in quantity supplied D. When considering supply curves, suppliers are interested in the relationship between a change in price and a change in the quantity supplied. 34
• 35. 34. When price increases from \$45 to \$55, the quantity supplied increases from 20 units to 30 units. The price elasticity of supply is a. 1/2 = 0.5 b. 1.0 c. 2.0C. *We always use the arc elasticity of demand and supply formula, that is, we use average values. Also, the sign is always positive because there is a direct relationship between the change in price and the change in quantity supplied.The percent change in the quantity supplied is 10/25 and the percent change in price is 10/50. So the price elasticity of supply is 10/25 divided 35 by 10/50 or 10/25 x 50/10 = 500/250 = 2.
• 36. 35. A perfectly elastic supply curve a. has no relevance, since real-world supply curves are never perfectly elastic b. is a horizontal straight line c. is a vertical straight line d. is not a straight lineB. A perfectly elastic supply curve is perfectly horizontal for the same reason that a perfectly demand curve is perfectly horizontal. In this case, a change in price will have an infinite effect on the change in the quantity supplied. 36
• 37. 36. Which of the following products would be most likely to have a perfectly inelastic supply curve? a. wheat b. cigarettes c. economic textbooks d. humidors used by President John F. Kennedy D. As price changes the suppliers of wheat, cigarettes, and economic textbooks can change the quantity supplied of these goods. But with the humidors used by Kennedy, the supply cannot be changed from what it is because the quantity is fixed. 37
• 38. 37. The most important determinant of price elasticity of supply is a. price elasticity of demand b. how rapidly costs increase when a firm increases its output c. whether the production process relies heavily on capital or on laborB. If the cost of supplying each additional unit rises sharply as output expands, then a higher price will elicit little increase in quantity supplied, so supply will tend to be inelastic. But if the additional cost rises slowly as output expands, the lure of a higher price will prompt a large increase in output and the supply curve is very price38 elastic.
• 39. 38. Tax incidence refers to a. who bears the burden of the tax b. the principle of taxation being applied c. the percent of a dollar of earned income which a typical household in that country pays in taxes d. the percent of government spending which is financed by taxes rather than by borrowing or by printing money A. If the government raises the sales tax across the board, who is affected the most? In this case, low income people will be effected more than high income people. 39
• 40. 39. The burden of a sales tax a. falls on consumers, who must pay the entire tax b. falls on producers, who must pay the entire tax c. is paid partly by consumers and partly by producers, depending on price elasticity of demand and price elasticity of supplyC. If a business can raise its price and its revenue increases, it can readily pass the tax increase on to the consumer. However, if a business raises its price and its revenue declines, it will end up paying most of the increase in sales tax. 40
• 41. 40. Consumers pay a larger proportion of a sales tax if a. demand and supply are both more elastic b. demand and supply are both less elastic c. demand is more elastic and supply is less elastic d. demand is less elastic and supply is more elastic D. The less elastic is the demand curve, the less effect there will be on the quantity demanded as the price increases. The more elastic is the supply curve for the good, the less the increase in costs effects the quantity supplied. 41
• 42. 41. Governments tend to tax products a. with inelastic demand, because it leads to higher revenue b. with elastic demand, because it leads to higher revenue c. with elastic demand, because it leads to higher business profit d. which they think are beneficial to society, because taxes lead to greater production A. This is because the higher price that results from the higher tax will not effect greatly the quantity demanded of the product. 42
• 43. 42. Economists distinguish between normal and inferior goods using a. price elasticity of demand b. price elasticity of supply c. income elasticity of demand d. tax incidenceC. A normal good is one that consumers will purchase more of as their incomes increase. An inferior good is one that consumers will buy less of as their incomes increase. 43
• 44. 43. An inferior good is defined as one for which demand increases as a. price decreases b. price increases c. income increases d. income decreasesD. New cars are an example of a normal good and used cars is an example of an inferior good. As consumer’s income decreases they will tend to purchase more used cars and fewer new cars. 44
• 45. 44. Luxury goods are usually a. price inelastic b. income inelastic c. income elastic d. goods with negative income elasticityC. A luxury good is one that consumers can live without. So as the price of luxury goods increase, there is a large effect on the quantity demanded as consumers choose to buy less of the good. 45
• 46. 45. Income elasticity of demand is important to producers because it indicates a. the probable decrease in sales when price is raised b. the probable increase in quantity supplied when price is raised c. how a firm’s sales react to movements of the economy through the business cycle d. how a firm’s total revenue changes in response to a price increase C. This question deals with income elasticity of demand and not price elasticity of demand. Movements in the economy effect consumer’s incomes. 46
• 47. 46. Which of the following is not a cause of special problems in U.S. agricultural markets? a. many factors which determine farm production are beyond the farmer’s control b. the demand for farm products tends to be price inelastic c. the demand for farm products tends to be income elastic C. How much consumers spend on food is not effected much by a change in their income. At least in America, if people’s income increases, they will tend to buy more new cars, but will spend about the same on food. 47
• 48. 47. A characteristic of many unregulated agricultural markets is that a. total farm revenue increases when there are bumper (large) crops and decreases when there are meager (small) crops b. total farm revenue decreases when there are bumper crops and it increases when there are meager crops c. total farm revenue increases when demand decreases and decreases when demand increases B. The bumper crops lead to such low prices that the farmer makes very little money. The shortage leads to higher prices enabling the farmer to make more money. 48
• 49. 48. Cross-price elasticity of demand is used to determine whether a. a product is an inferior or normal good b. a product is a necessity or a luxury c. two products are substitutes or complements d. price and total revenue are directly or inversely relatedC. When two products are related, a change in the price of one will effect the demand for the other. For example, steak and steak sauce are related. As the price of steak changes, the demand for steak sauce will change. 49
• 50. 49. Substitutes are defined as products with a. positive cross-price elasticity of demand b. negative cross-price elasticity of demand c. positive income elasticity of demand d. negative income elasticity of demandA. Sherbet is a substitute for ice cream. As the price of ice cream increases, consumers will tend to buy more sherbet. The cross-price elasticity of demand is positive, in this case, because as the price of ice cream increases there is a corresponding increase in the demand for sherbet. 50
• 51. 50. Negative cross-price elasticity of demand indicates that a. the product is an inferior good b. the product is a necessity c. the product is a luxury d. the two products are complementsD. Steak and steak sauce are complementary goods because they tend to be used together. As the price of steak increases (people will therefore buy less steak) the demand for steak sauce will decrease. The cross-price elasticity is negative because the increase in price leads to a decrease in the quantity demanded. 51
• 52. Price Demand Last slide viewed QuantityExhibit 18.1 52
• 53. 51. The price elasticity of demand in Exhibit 18-1 is a. unit elastic b. somewhat elastic c. perfectly elastic d. perfectly inelastic D. It is perfectly inelastic because a change in price will have no effect on the quantity demanded. 53
• 54. 52. What is the price elasticity of demand in Exhibit 18-1 ? a. 0 b. -1 c. negative infinity d. 1 A. The price elasticity of demand is the percent change in quantity divided by the percent change in price. In this case there is 0 change in the quantity demanded as the price changes. 54
• 55. Price Last slide viewed De\$40 ma n d\$20 0 6 8 QuantityExhibit 18.2 55
• 56. 53. What is the price elasticity of demand between \$20 and \$40 in Exhibit 18-2? a. -1 b. -3/7 c. -2 1/3 d. -7B. The percent change in quantity is 2/7 and the percent change in price is 20/30 so the price elasticity of demand is 2/7 x 30/20 = 60/140 = 6/14 = 3/7. *Remember, your author uses the negative sign when referring to elasticity of demand. 56
• 57. 54. What is the price elasticity of demand in the segment of the demand curve below \$40 and above \$20 in Exhibit 18-2? a. elastic b. inelastic c. unit elastic d. 0B. It is inelastic because 3/7 is less than one. An elasticity greater than one is elastic, a value of one is unitary elastic, and a value of less than one is inelastic. 57
• 58. 55. If a firm’s demand curve is illustrated in Exhibit 18-2 and it is currently charging \$20, its total revenue will a. remain unchanged, if it changes its price slightly b. increase, if it lowers its price substantially c. increase, if it lowers its price slightly d. increase, if it raises its price slightlyD. This is because the demand curve is price inelastic, which means that the firm can raise price and its total revenue will increase. 58
• 59. Price Last slide viewed 1 S\$40 S\$20\$10 Quantity 0 100 200Exhibit 18.3 59
• 60. 56. What is the price elasticity of supply between \$10 and \$20 on supply curve S in Exhibit 18-3? a. 0 b. infinity c. 1 d. 2C. Price elasticity of supply is the percent change quantity divided by the percent change in price. The percent change in quantity is 100/150 and the percent change in price is 10/15. So price elasticity of supply is 100/150 x 15/10 = 1500/1500 = 1 60
• 61. 57. What is the price elasticity of supply between \$20 and \$40 on supply curve S 1 in Exhibit 18-3? a. 0 b. infinity c. 1 d. 2C. The percent change in quantity is 100/150 and the percent change in price is 20/30. So the price elasticity of supply is 100/150 x 30/20 = 3000/3000 = 1 61
• 62. 58. Which supply curve tends to be more elastic in Exhibit 18-3? a. both S and S1 have the same elasticity b. S is more elastic at lower prices, and S’ is more elastic at higher prices c. S d. S1A. Both have a price elasticity of one. 62
• 63. END