18e Key Question Answers Ch 6 1qn4f

6-2

6-3

(Key Question) Graph the accompanying demand data, and then use the midpoint formula for Ed to determine price elasticity of demand for each of the four possible $1 price changes. What can you conclude about the relationship between the slope of a curve and its elasticity? Explain in a nontechnical way why demand is elastic in the northwest segment of the demand curve and inelastic in the southeast segment. Product Price

Quantity demanded

$5 4 3 2 1

1 2 3 4 5

See the graph accompanying the answer to 6-3. Elasticities, top to bottom: 3; 1.4; .714; . 333. Slope does not measure elasticity. This demand curve has a constant slope of -1 (= -1/1), but elasticity declines as we move down the curve. When the initial price is high and initial quantity is low, a unit change in price is a low percentage while a unit change in quantity is a high percentage change. The percentage change in quantity exceeds the percentage change in price, making demand elastic. When the initial price is low and initial quantity is high, a unit change in price is a high percentage change while a unit change in quantity is a low percentage change. The percentage change in quantity is less than the percentage change in price, making demand inelastic. (Key Question) Calculate total-revenue data from the demand schedule in question 2. Graph total revenue below your demand curve. Generalize about the relationship between price elasticity and total revenue. See the graph. Total revenue data, top to bottom: $5; $8; $9; $8; $5. When demand is elastic, price and total revenue move in the opposite direction. When demand is inelastic, price and total revenue move in the same direction.

6-4

6-5

6-8

(Key Question) How would the following changes in price affect total revenue? That is, would total revenue increase, decline, or remain unchanged? a. Price falls and demand is inelastic. b. Price rises and demand is elastic. c. Price rises and supply is elastic. d. Price rises and supply is inelastic. e. Price rises and demand is inelastic. f. Price falls and demand is elastic. g. Price falls and demand is of unit elasticity. Total revenue would increase in (c), (d), (e), and (f); decrease in (a) and (b); and remain the same in (g). (Key Question) What are the major determinants of price elasticity of demand? Use those determinants and your own reasoning in judging whether demand for each of the following products is probably elastic or inelastic: (a) bottled water; (b) toothpaste; (c) Crest toothpaste; (d) ketchup; (e) diamond bracelets; (f) Microsoft Windows operating system. Substitutability, proportion of income; luxury versus necessity, and time. Elastic: (a), (c), (e). Inelastic: (b), (d), and (f). (Key Question) What is the formula for measuring the price elasticity of supply? Suppose the price of apples goes up from $20 to $22 a box. In direct response, Goldsboro Farms supplies 1200 boxes of apples instead of 1000 boxes. Compute the coefficient of price elasticity (midpoints approach) for Goldsboro’s supply. It its supply elastic, or is it inelastic? Es = percentage change in quantity supplied / percentage change in price.

6-9

6-10

6-15

Using the midpoint formula, Es = 1.91 {= (200/[(1000+1200)/2] / 2/[(20+22)/2]} Supply is price elastic (Es>1). (Key Question) Suppose the cross elasticity of demand for products A and B is +3.6 and for products C and D is -5.4. What can you conclude about how products A and B are related? Products C and D? A and B are substitutes; C and D are complements. (Key Question) The income elasticities of demand for movies, dental services, and clothing have been estimated to be +3.4, +1.0, and +0.5 respectively. Interpret these coefficients. What does it mean if the income elasticity coefficient is negative? All are normal goods—income and quantity demanded move in the same direction. These coefficients reveal that a 1 percent increase in income will increase the quantity of movies demanded by 3.4 percent, of dental services by 1.0 percent, and of clothing by 0.5 percent. A negative coefficient indicates an inferior good—income and quantity demanded move in the opposite direction. (Key Question) Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient. Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas? When the consumers’ utility exceeds the price paid, consumer surplus is generated. Likewise, when producers receive a price greater than marginal cost, producer surplus is created. By producing up to the point where MB = MC, the maximum potential consumer surplus and producer surplus is generated. Producing less than the equilibrium level means that potential surplus is left unrealized. Overproduction subtracts from the surplus because society values the use of the additional resources in other pursuits more than it values them in consumption of that good.