Handout 4 (Demand and Supply - Elasticities) with Solutions

Handout 4 Demand and Supply - Elasticities This handout contains exercises of - Demand and Supply: Elasticities o (Own) Price Elasticity of Demand
Point Calculation / Midpoint Percentage Calculation
Revenue Maximization o Cross-Price Elasticity of Demand o Income Elasticity of Demand o Price Elasticity of Supply Things you should know - See Kanit’s Midterm 1 Review Sheet (which also includes the formulation) Exercises Question 0 Write down and explain the formulas and intuitions of all elasticities we have studied. Question 1 (Price Elasticity of Demand: Calculating Elasticities) 1. What can be concluded if the price elasticity of demand is -1.5? What can we say about this demand of this good at this moment? 2. Suppose price of a good increases from $3 to $5 causing the quantity demanded to decrease from 10 units to 6 units. What is the price elasticity of demand using midpoint percentage? 3. Suppose the demand curve for a good is given by P = 10 – 0.5Q. Find the price elasticity of demand: a. when the price is $3. b. when the quantity is 7 units. c. when the price is $5. (You should know something about this number.) 4. If the price elasticity of demand is -1 when the current price is $2 and current quantity is 10 units. What is the slope of the demand curve? Question 2 Suppose the demand for Tuberculosis drug is given by Q = 100. Draw this demand curve. 1. If the price of this drug increases from $13.5 to $750, what is the effect to the quantity demanded? What is the price elasticity of demand? 2. Suppose supply decreases, what would happen to the equilibrium price and quantity? Question 3 (Income Elasticity of Demand) 1. Suppose income increases by 10% causes the quantity demanded to decrease by 10%, what is the income elasticity of demand? What can be said about this good at current situation? 2. Suppose income increases from $14,000 to $16,000 causes the quantity demanded of a good to change from 590 units to 610 units. What is the income elasticity of demand calculated using midpoint percentage? What can we say about the characteristic of this good? Question 4 (Cross-price Elasticity of Demand) 1. If the price of ski boots increases, then the [ quantity demanded / demand ] of ski boots would [ increases / decreases ]. This causes the [ quantity demanded / demand ] of skis to [ increases / decreases ]. That is, there is a [ shift / movement along ] the demand curve for skis to the [ left / right ]. Thus, the cross price elasticity of demand for skis with respect to ski boots price is [ negative / positive ]. In other words, skis and ski boots are [ complements / substitutes ]. 1 2. A 10 percent decrease in the price of corn causes the demand for the zucchini to decrease by 10 percent. What is the cross price elasticity of demand for zucchini with respect to the price of corn? What can we say about corn and zucchini? Question 5 (Revenue Maximization) 1. In a linear demand curve, when the demand is elastic, a decrease in price causes a [ large / small ] increase in quantity demanded. Therefore, total revenue, which is price times quantity, [ decreases / increase ]. 2. Suppose the demand curve is given by P = 20 – 2Q. a. If the current quantity sold is 2 units, an increase in price will [ increase / decrease ] the total revenue. b. If the current price is $4, an decrease in price will [ increase / decrease ] the total revenue. c. At what price and quantity does the producer maximize the total revenue? 2