Practice Problems -- Answer Key

Multiple choice questions.
1.The price elasticity of demand is:
a) the ratio of the percentage change in quantity demanded to the percentage change in price.
b) the responsiveness of revenue to a change in quantity.
c) the ratio of the change in quantity demanded divided by the change in price.
d) the response of revenue to a change in price.

2.If demand is price elastic, then:
a) a rise in price will raise total revenue.
b) a fall in price will raise total revenue.
c) a fall in price will lower the quantity demanded.
d) a rise in price won't have any effect on total revenues.

3. Complementary goods have:
a) the same elasticities of demand.
b) very low price elasticities of demand.
c) negative cross price elasticities of demand with respect to each other.
d) positive income elasticities of demand.

4. The price elasticity of demand generally tends to be:
a) smaller in the long run than in the short run.
b) smaller in the short run than in the long run.
c) larger in the short run than in the long run.
d) unrelated to the length of time.

5. If the price elasticity of supply of doodads is 0.60 and the price increases by 3 percent, then the quantity supplied of doodads will rise by
a) 0.60 percent.
b) 0.20 percent
c) 1.8 percent
d) 18 percent.

6. Suppose we know that the price elasticity of demand of good X is equal to -1.2. Then, if its price will increase by 5%, we can predict with certainty that
a) quantity demanded of that good will increase.
b) the revenue of the firm producing that good will increase by 6%.
c) the revenue of the firm producing that good will decrease by 6%.
d) the quantity demanded of that good will decrease by 6%.
e) None of the above.

7. A 10% increase in the price of movie ticket in Westridge 8 leads to a 15% decrease in the number of tickets sold, indicating the demand for movie ticket in Westridge 8 is:
a) elastic.
b) inelastic.
c) unit elastic.
d) Can not tell from the information given.

8. If the cross-price elasticity between two commodities is 1.5,
a) the two goods are luxury goods.
b) the two goods are complements.
c) the two goods are substitutes.
d) the two goods are normal goods.

For each of the following statements, say whether it is true, false, or uncertain and explain your answer.

1. It is reasonable to expect the cross price elasticity of demand for golf clubs and golf balls to be positive.

Golf clubs and golf balls are complementary goods. This means that, as the price of golf clubs increases (a positive change), the consumption of golf balls decreases (a negative change). Cross price elasticity of demand is equal to the ratio of these changes and will be negative. The statement is false.

2. If the demand is perfectly elastic, then a shift in the supply curve does not affect the equilibrium price.

True, because a perfectly elastic demand curve is horizontal. Therefore, no matter what the shift is the equilibrium price will always remain the same. (See graph.) S and D graph

3. The demand curve for autos is more elastic than the demand curve for Fords.

False. A Ford can be substituted by a different model. It is not as easy to find a substitute for a car in general. The more substitutes a good has, the more elastic is the demand for that good. Therefore, demand for Fords is more elastic.

4. Suppose you own a "Here Comes the Sun" tanning salon and the demand curve for your services is downward sloping. Further, suppose that a new tanning salon called "Sunny Delight" opens two blocks away from your salon. Tell whether the following three statements are true, false or uncertain and explain your answer.

a. The demand curve for your services shifts to the right.
This new salon is a substitute for your services. After it has appeared, your consumers have more choice, and some of them will start using the new salon. So the demand for your services will decrease, or shift to the left.
The statement is false.

b. The demand for your services becomes more elastic.
One of the factors determining the price elasticity of demand for the good is the number of substitutes. More substitutes - more elastic demand.
The statement is true.

c. The cross-price elasticity of the demand for your services with respect to the price charged by "Sunny Delight" is negative.
These two goods (services) are substitutes. The cross-price elasticity of substitutes is positive, since as the price of one of them increases, the demand for (and therefore the consumption of) the other one increases, too.
The statement is false.

Short Answer Question.
5. Initially Hans Johnson was the only consumer in the market for "Casa de Econ" beer, produced by a small local brewery. When the price of "Casa de Econ" six-pack varies between $10 and $20, the price elasticity of his individual demand is equal to negative 1. Now imagine that Hans has been cloned 4 times, and now we have 5 identical consumers in the market for "Casa de Econ". What will happen to the price elasticity of market demand in the price range given above? Will the demand become more price elastic, less price elastic, or will elasticity stay the same? Explain your answer.

Since elasticity deals with relative changes, it doesn't matter how many consumers we have in the market as long as all of them are same. (If the quantity demanded for each of them changes by 50%, that would mean the quantity demanded in the entire market will change by 50%, too.) So the price elasticity of demand will stay the same.


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