Price Elasticity of Demand Answers

Elasticity – Seminar Guide Seminar 4 – Questions Complete the following questions during the tutorial session in class: Price Elasticity of Demand 1. If the demand for a certain product is said to be inelastic it means:- a) b) c) d) a small increase in price will lead to a big drop in the amount demanded a small increase in price will lead to a small rise in the amount demanded consumers are rather insensitive to price changes. large changes in price have only a small effect on demand. Hint: more than one is correct c and d Reasoning: Inelastic demand means that consumers are not very responsive to price changes. For products with inelastic demand, large changes in price result in only small changes in the quantity demanded. Essentials like medication often have inelastic demand, as people still need to buy them despite price increases. What are the most important factors affecting the elasticity of demand for a product? 2. Answer: The main factors are:    Availability of substitutes: Products with close substitutes are more elastic because consumers can easily switch if the price rises. Necessity vs. luxury: Necessities are usually inelastic, as people need them regardless of price, while luxuries are more elastic. Time period: Demand is more elastic over the long term, as consumers have time to find alternatives. Reasoning: These factors affect consumers' ability and willingness to adjust their buying habits when prices change. 3. Which will be more elastic: the demand for Cadbury's Fruit 'n Nut or the demand for chocolate generally? Explain your reasoning. Cadbury’s Fruit’n Nut, it has more substitutes : Answer: The demand for Cadbury’s Fruit 'n Nut is more elastic. Reasoning: Cadbury’s Fruit 'n Nut has more substitutes (other chocolate brands and flavours). Consumers are more likely to switch to other chocolates if the price of Fruit 'n Nut rises. However, the demand for chocolate in general is less elastic because it is a broader category with fewer substitutes outside of chocolate itself. 1 Elasticity – Seminar Guide 4. Consider the estimates of the price elasticity of demand for certain foods shown in the following table. Explain why the demand for fruit juice is more elastic than that for milk. How do you explain the difference between the elasticity of demand for chicken and that for other poultry? Estimates of the price elasticity of demand for certain foods Bread Milk Sugar Fresh potatoes Other fresh vegetables -0.09 -0.19 -0.09 -0.21 -0.27 Fruit juices -0.80 Cheese -1.20 Carcass meat Other meat and meat products of which: bacon and ham chicken (not free range) other poultry frozen convenience meat and meat products -1.37 -0.49 -0.70 -0.13 -0.85 -0.94 Source: Annual report of the National Food Survey Committee MAFF 1989 Table 5.2 These estimates are derived from survey data for the period 1984 to 1989 Answer:   Fruit juice is more elastic than milk because it has more substitutes (like soda, tea, or other juices), making consumers more responsive to price changes. Milk is a necessity with fewer close substitutes, making it inelastic. For chicken vs. other poultry:   Chicken has fewer substitutes within its category, especially among commonly consumed meats, so its demand is inelastic. Other poultry has more substitutes within the broader meat market, making its demand more elastic. 5. On the Friday of each week a petrol-filling station cuts the price of petrol from 140p to 133p per litre. Sales on Fridays rise to 12 000 litres per day, which compares with an average of 10 000 litres per day during the rest of the week. Use this information to calculate the price elasticity of demand facing the filling station. Give two reasons why this estimate may not be valid. (6 marks) Answer 2 Elasticity – Seminar Guide %∆Q= (12000-10000)/10000x100= +20% %∆P= (133-140)/140x100=-5% PED = %∆Q/%∆P PED = 20/-5 PED=- 4 Answer: The PED is -4, indicating that demand is elastic. Reasons for invalidity: 1. Timing of the price cut: It’s Friday, when people may need petrol for weekend trips, which can inflate demand beyond normal elasticity. 2. Income effect: People might receive paychecks on Friday, making them more likely to purchase petrol regardless of the price change. People get paid on Friday, they might need petrol for the weekend etc Income Elasticity of demand 6. What in economics is meant by an "inferior good"? State which of the following goods you would expect to be normal and which inferior: standard white loaves croissants remould tyres Earl Grey tea Tesco’s baked beans McDonalds’ hamburgers coffee 3 Elasticity – Seminar Guide rice package holidays to Spain Answer:    Inferior Good: A good where demand decreases as income rises. Likely Inferior Goods: Standard white loaves, remould tyres, Tesco’s baked beans, McDonald’s hamburgers. Likely Normal Goods: Croissants, Earl Grey tea, coffee, rice, and package holidays to Spain. Reasoning: Inferior goods are often basic or budget options, which people may substitute with higher-quality alternatives as their income increases. 7. The following statements relate to the term inferior good as used in economics. Choose the two that are correct. a) b) c) d) e) If your income goes up you will buy less of the good in question. The term "inferior good" is a subjective term. It means the person speaking doesn't like the good in question. An inferior good is a good of low quality If the good in question has a negative income elasticity of demand it is termed inferior. The good in question will have a negative price elasticity of demand. Answers: · a) If your income goes up, you will buy less of the good in question. ✅ · d) If the good has a negative income elasticity of demand, it is considered inferior. ✅ Reasoning: An inferior good is defined economically by its negative income elasticity, meaning demand falls as income rises. It’s not based on quality or personal preference. 8. Some of the estimates of income elasticity shown below are negative? What does this imply? Estimates of the income elasticity of demand for certain foods (1989) milk margarine potatoes sugar and preserves -0.40 -0.25 -0.48 -0.54 bread cakes and biscuits -0.25 0.02 tea instant coffee -0.56 0.23 4 Elasticity – Seminar Guide cheese of which: natural processed 0.19 fruit juices yoghurt fresh vegetables 0.94 0.58 0.35 0.22 -0.12 Answer: A negative income elasticity means these goods are inferior goods—demand decreases as income rises. Examples from the list include margarine and standard white bread. Price and Income elasticity – one or the other or both 9. Recently sales of natural gas have risen despite an increase in its price. Does this mean that the demand curve for natural gas is upward sloping? How else could you explain the phenomenon? Answer: No, this does not imply an upward-sloping demand curve. Reasoning: Other factors, like a colder-than-average winter or reduced availability of substitutes, may increase demand despite higher prices. This phenomenon can occur without altering the basic downward-sloping nature of the demand curve. 10. Why do shops have January sales? Answer: Shops hold January sales because demand is more elastic in January after the holiday season, as consumers are more price-sensitive due to recent holiday spending. Lowering prices encourages purchases during this period. 11. Suppose the price elasticity of demand for petrol is estimated to be -0.1 and the income elasticity is estimated to be +1.2 State whether the following statements are true or false:- a) true b) a tax on petrol will not have much effect on consumption true a tax on petrol will raise lots of revenue because demand is inelastic c) a rise in incomes of 10% will lead to an increase in the amount of petrol bought of more than 10 percent. true d) true the price and quality of public transport, and the presence or absence of cycleways, will affect the elasticity of demand for petrol 5 Elasticity – Seminar Guide Reasoning:    Petrol’s inelastic demand means that a price increase won’t drastically reduce consumption, but will generate revenue. Petrol has a positive income elasticity, so as income rises, so does petrol demand. Availability and quality of transport alternatives influence petrol demand elasticity. Cross-price elasticity of demand 12. State whether you would expect the cross-price elasticity of demand between the following goods to be positive, negative or zero, and explain why. a) b) c) d) e) f) g) margarine and butter petrol and motor vehicles coffee and cocoa motor cycles and motor cycle helmets CD players and CDs coal and gas holidays in Ireland and holidays in Scotland Answers:        a) Margarine and butter: Substitutes (positive XED) b) Petrol and motor vehicles: Complements (negative XED) c) Coffee and cocoa: Substitutes (positive XED) d) Motorcycles and helmets: Complements (negative XED) e) CD players and CDs: Complements (negative XED) f) Coal and gas: Substitutes (positive XED) g) Holidays in Ireland and holidays in Scotland: Substitutes (positive XED) Reasoning: Substitute goods have a positive XED because an increase in the price of one increases demand for the other. Complementary goods have a negative XED because an increase in the price of one reduces demand for the other. 13. Assume the cross-price elasticity of demand for white grapes with respect to black grapes is +2. If the price of black grapes falls by 8% what will happen to the demand for white grapes? 6 Elasticity – Seminar Guide Answer: Demand for white grapes decreases by 16%. Reasoning: As black grapes become cheaper, consumers buy fewer white grapes, shifting their demand to black grapes. Elasticity of Supply The elasticity of supply is defined as:percentage increase in quantity supplied percentage increase in price 14. The following table shows the output of an agricultural commodity over a ten year period together with the price 1980 1990 output 100 300 price (£/tonne) 16 32 Based on this data work out the coefficient for the elasticity of supply. Which of the following statements are true: a) The supply of this commodity seems to be inelastic. False b) The percentage increase in output is more than the percentage increase in price. Therefore supply is said to be elastic. True c) We would expect supply to be elastic since it is easier for farmers to switch from growing one crop to another than it is for industry to switch from producing one manufactured product to another. True 7 Elasticity – Seminar Guide %∆Q= +200% %∆P= =100% PES = %∆Q/%∆P PES = 200/100 PED=+2 Answer: PES is 2, indicating elastic supply. Reasoning: Since the percentage change in quantity supplied is greater than the percentage change in price, supply is elastic, meaning producers can respond quickly to price changes. 8