TUTORIAL 2 ELASTICITY

INTRODUCTION TO ECONOMICS
ACCOUNTING CLASS

SHORT ESSAY

1. Consider the following pairs of goods. For which of the two goods would you expect the
demand to be more price elastic? Why?
a. water or diamonds
Answer :, Water is necessity, and diamonds are luxuries. Therefore, diamonds
have the more elastic demand.

b. insulin or nasal decongestant spray

Answer : Insulin has no close substitutes. But, nasal decongestant spray does.
Therefore, nasal decongestant spray has the more elastic demand.

c. food in general or breakfast cereal

Answer : Breakfast cereal have more substitutes, than does the food in general
have substitutes. Therefore, breakfast cereal has the more elastic demand.

d. gasoline over the course of a week or gasoline over the course of a year
Answer : Its about the longer time period, the more elastic demand is. Therefore,
gasoline over the course of a year has the more elastic demand.

e. personal computers or IBM personal computers

Answer : The IBM personal computers have more substitutes than for the personal
computers. Therefore, IBM personal computers have the more elastic demand.

2. You own a small town movie theatre. You currently charge $5 per ticket for everyone who
comes to your movies. Your friend who took an economics course in college tells you that
there may be a way to increase your total revenue. Given the demand curves shown, answer
the following questions.

Price
10

2 Adult Demand
1

10 20 30 40 50 60 70 80 90 100 Quantity
 Price
10

2 Child Demand
1

5 10 15 20 25 30 35 40 45 50 55 60 65 70 Quantity

a. What is your current total revenue for both groups?

Answer : P = $5
Adult Quantity = 50
Child Quantity = 20

The formula for total revenue is P x Q. So, the total revenue for :
- Adult = $5 x 50 = $250
- Child = $5 x 20 = $100
Finally, we got $250 for the adult market and $100 for the children's
market. After that, we have to add up all the totals, so that we get
$350 for the total of all revenues.

b. The elasticity of demand is more elastic in which market?

Answer : The elasticity of demand is more elastic in the children's market. Because
the flatter demand curve implies elastic demand.

c. Which market has the more inelastic demand?

Answer : The adult ticket market has the more inelastic demand, because the demand
curve is relatively steep.

d. What is the elasticity of demand between the prices of $5 and $2 in the adult market?
Is this elastic or inelastic?
Answer : P = $2 Qd = 60
P = $5 Qd = 50

Use standard method to calculate :

The % change to P equals :

Start from $2 to $5
( $5 − $2) $3
𝑥 100% = 𝑥 100% = 1.5%
$2 $2
 The % change to Q equals :
Start from 60 to 50 :
(60 − 50) 10
𝑥 100% = 𝑥 100% = 20%
50 50

So, from $2 to $5, P rises 1.5%, Q falls 20%, the elasticity is

20
= 13.3 (elastic demand)
1.5

The % change to P equals :

Start from $5 to $2 :
( $2 − $5 ) $3
𝑥 100% = 𝑥 100% = 60%
$5 $5

The % change to Q equals :

Start from 50 to 60 :
( 50 − 60 )
𝑥 100% = 16.67% 𝑟𝑜𝑢𝑛𝑑𝑖𝑛𝑔 𝑜𝑓𝑓 16.7%
60

So, from $2 to $5, P falls 60%, Q rises 17%, the elasticity is

16.7
= 0.28 (inelastic demand)
60

Use midpoint method to calculate :

The % change to P equals :
$5 − $2
𝑥 100% = 85.7%
$3.5

The % change in Q equals :

50 − 60
𝑥 100% = 18.2%
55

18.2
The price elasticity of demand equals = 0.22 (inelastic demand)
85.7

e. What is the elasticity of demand between $5 and $2 in the children's market? Is this
elastic or inelastic?
Answer : P = $2 Qd = 50
P = $5 Qd = 20

Use standard method to calculate :

The % change to P equals :

Start from $2 to $5
( $5 − $2) $3
𝑥 100% = 𝑥 100% = 1.5%
$2 $2
 The % change to Q equals :
Start from 20 to 50 :
(50 − 20) 30
𝑥 100% = 𝑥 100% = 150%
20 20

So, from $2 to $5, P rises 1.5%, Q falls 20%, the elasticity is

1.5
= 0.01 (inelastic demand)
150

The % change to P equals :

Start from $5 to $2 :
( $2 − $5 ) $3
𝑥 100% = 𝑥 100% = 60%
$5 $5

The % change to Q equals :

Start from 50 to 20 :
( 20 − 50 ) 30
𝑥 100% = 𝑥 100% = 60%
50 50

So, from $2 to $5, P falls 60%, Q rises 60%, the elasticity is

60
= 1 (unit elastic demand)
60

Use midpoint method to calculate :

The % change to P equals :
$5 − $2
𝑥 100% = 85.7%
$3.5

The % change in Q equals :

20 − 50
𝑥 100% = 85,7%
35

85.7
The price elasticity of demand equals = 1 (unit elastic demand)
85,7

f. Given the graphs and what your friend knows about economics, he recommends you
increase the price of adult tickets to $8 each and lower the price of a child's ticket to
$3. How much could you increase total revenue if you take his advice?
Answer : P = $8 Adult Quantity = 40
P = $3 Child Quantity = 40

The formula for total revenue is P x Q. So, the total revenue for :
- Adult = $8 x 40 = $320
- Child = $3 x 40 = $120
 Finally, we got $ 320 for the adult market and $ 120 for the children's
market. After that, we had to add up all the totals, so that we got $ 440
for the total of all revenues.

However, after the price change, there was an increase in total revenue
by $ 90 or around 26% to $ 440 and a decrease in the number of visitors
from 70 (50 adult markets and 20 children's markets) has now increased
to 80 (40 adult markets and 40 children's market).

3. Use the graph shown to answer the following questions. Put the correct letter(s) in the blank.
Price
A

Demand
C Quantity

a. The elastic section of the graph is represented by section from __A to B.

b. The inelastic section of the graph is represented by section from __B to C.
c. The unit elastic section of the graph is represented by section ___B.
d. The portion of the graph in which a decrease in price would cause total revenue
to fall would be from ___B to C.
e. The portion of the graph in which a decrease in price would cause total revenue
to rise would be from ____A to B.
f. The portion of the graph in which a decrease in price would not cause a change
in total revenue would be ___B.
g. The section of the graph in which total revenue would be at a maximum would
be ___B.
h. The section of the graph in which elasticity is greater than 1 is ___A to B.
i. The section of the graph in which elasticity is equal to 1 is ___B.
j. The section of the graph in which elasticity is less than 1 is ___B to C.

4. Using the midpoint method, compute the elasticity of demand between points A and B. Is
demand along this portion of the curve elastic or inelastic? Interpret your answer with
regard to price and quantity demanded. Now compute the elasticity of demand between
points B and C. Is demand along this portion of the curve elastic or inelastic?
 Price
22

20
A
18

16

14
B
12

10

8
C
6

2
Demand
100 200 300 400 500 600 700 800 900 Quantity

Answer :
In the section of the demand curve from A to B would be
The % change to P equals :
$18 − $12
𝑥 100% = 40%
$15

The % change in Q equals :

300 − 100
𝑥 100% = 100%
200

100
The price elasticity of demand from A to B equals = 2.5 (elastic demand)
40
This would be an elastic portion of the curve. This would mean that for every 1%
change in price, the quantity demanded would change by 2.5%

In the section of the demand curve from B to C would be

The % change to P equals :
$6 − $12
𝑥 100% = 66.7%
$9

The % change in Q equals :

500 − 300
𝑥 100% = 50%
400

50
The price elasticity of demand from B to C equals = 0.75 (inelastic
66.7
demand)
This would be an inelastic portion of the curve. This would mean that for every
1% change in price, the quantity demanded would change by 0.75%

5. When the Shaffers had a monthly income of $4,000, they usually ate out 8 times a month.
Now that the couple makes $4,500 a month, they eat out 10 times a month. Compute the
 couple's income elasticity of demand using the midpoint method. Explain your answer. (Is
a restaurant meal a normal or inferior good to the couple?)
Answer : In this section:
The % change to P equals :
$4500 − $4000
𝑥 100% = 11.8%
$4250

The % change in Q equals :

10 − 8
𝑥 100% = 22.2%
9

22.2
The price elasticity of demand equals would be = 1.89 (elastic
11.8
demand).
The income elasticity of demand for the Shaffers is 1.89. Since the income
elasticity of demand is relatively high positive, this would be interpreted as
a normal good. Restaurant meals are normal goods, in this case, because
when income rises, they ate more in restaurants, then the units consumed
for this good increase too.

6. Recently, in small town, the price of Twinkies fell from $0.80 to $0.70. As a result, the
quantity demanded of Ho-Ho's decreased from 120 to 100. What would be the appropriate
elasticity to compute? Using the midpoint method, compute this elasticity. What does your
answer tell you?
Answer : In the section of the demand curve would be
The % change to P equals :
$0.70 − $0.80
𝑥 100% = 13.3%
$0.75

The % change in Q equals :

100 − 120
𝑥 100% = 18.18%
110

18.18
The price elasticity of demand from Q to P equals = 1.36 (elastic
13.3
demand).
The appropriate elasticity to compute would be cross-price elasticity.
Because 1.36 of these two goods are substitutes for the cross-price
elasticity is positive.