Week4-Tutorial Question-Economic Principles

ECO10004: ECONOMIC PRINCIPLES
WEEK 4_TUTORIAL QUESTIONS

Key concepts: Elasticity, Price Elasticity of Demand, Elastic, Inelastic, Cross-price Elasticity
of Demand, Income Elasticity of Demand.
Note: The questions below are also your homework for Week 4.
Make sure to complete and submit your answers on Canvas by Sunday, 29th August.
Short-answer Questions
Question 1) In high-income countries (such as Australia), the price elasticity of demand for
cigarettes is estimated to be about -0.4.
Which of the following statements best describes this price elasticity of demand?
a. When the price of cigarettes increases by $1, the demand for cigarettes decreases by
0.4 units.
b. When the price of cigarettes increases by $1, the quantity demanded for cigarettes
decreases by 0.4 units.
c. When the price of cigarettes increases by 1%, the demand for cigarettes decreases by
0.4%
d. When the price of cigarettes increases by 1%, the quantity demanded for cigarettes
decreases by 0.4%.
Clearly explain why the answer of your choice is correct while the other three alternatives
are incorrect.
Is the quantity demanded for cigarettes in Australia sensitive or insensitive to a change in
price?
Do you think the demand for cigarettes in Australia is price elastic or price inelastic?
Clearly explain why.
ANSWER:
D
Because A and B are in the wrong units, the unit of price elasticity of demand for
cigarettes is the percentage (%). C is incorrect because it is the quantity demand, not the
demand for cigarettes.
The quantity demanded for cigarettes in Australia is insensitive to change in price
because the price elasticity of demand for cigarettes is 0.4%, less than 1.
The relationship between price and quantity demanded is inverse and the price elasticity
of demand for cigarettes is about 0.4%, less than 1, so the demand for cigarettes in
Australia is price inelastic.
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Question 2) Aran owns a bookstore. He is currently selling 40 copies per day of the latest
J.K.Rowling novel (a sequel to the Harry Potter series) at a price of $35. Aran is thinking
of lowering the price to $25. He believes this will increase the quantity sold to 50 books
per day.
a. Using the mid-point formula and based on the data above, calculate the price elasticity
of demand for the latest J.K.Rowling novel in Aran’s bookstore
ANSWER:
Applying the mid-point formula:

( 50 − 40 )  ( 25 − 35) = − 2
( 50 + 40 ) ( 25 + 35) 3
2 2
b. Is the demand for the novel elastic or inelastic?
ANSWER:
2
The demand for the novel is inelastic because the price elasticity of demand is less
3
than 1.
c. Should Aran go ahead and reduce the selling price? How will that decision affect
Aran’s total revenue earned from this novel?
ANSWER:
If Aran does not reduce the price so the total revenue is 40 x $35 = $1,400
If Aran decrease the price so the total revenue is 50 x $25 = $1,250
$1,250 < $1,400→ Aran should not go ahead and reduce the selling price because it does
not raise sales quantity but also reduce the total revenue.
Question 3) One of the questions in a micro online test is as follows:
“The price elasticity of demand for low-fat milk in Australia is estimated at -2.07
(Sharma et al 2014).
Do you think the demand for low-fat milk in Australia is price elastic or price inelastic?”
In response to the above question, Vu (a not-so-bright 1st year economics student) writes
the following answer:
“The price elasticity of demand for low-fat milk is -2.07. It’s a negative number, thus, it’s
lower than 0. Since it’s lower than 0, it’s definitely lower than 1. Therefore, the demand
for low-fat milk in Australia is inelastic.”
Do you agree or disagree with Vu’s answer above? Clearly explain why.
ANSWER:
I disagree with Vu’s answer.
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The price elasticity of demand for low-fat milk is -2.07 → the absolute number is
−2.07 = 2.07  1 so the demand for low-fat milk in Australia is price elastic.
Question 4) Harrison owns a dairy farm in Western Victoria. There are about 1,500 dairy
farms in the same region. All dairy farms here, Harrison’s included, sell milk to at the
price of 50 cents per litre. The buyers are Woolworths and Coles, the two biggest
supermarket chains in Australia.
Last month, Harrison decided to raise his price to 55 cents per litre while his competitors
kept the price unchanged. After raising his price, Harrison noticed that his buyers stopped
doing business with him. Consequently, Harrison’s sales last month crashed to zero.
What you can say about the price elasticity of demand for Harrison’s milk? Clearly
explain.
How would you illustrate the demand curve for Harrison’s milk on a graph?
Note: This question does not focus on the price elasticity of demand for milk overall. It
concentrates on the price elasticity of demand for milk supplied by Harrison in particular.
ANSWER:
At the price of 50 cents, the quantity demanded is unlimited. So, Harrison should not
change the price to get the highest revenue. Because when the price was increased, the
quantity demanded is zero so that is the reason why Harrison could not sell any product
and the price elasticity of demand was perfectly elastic.
Question 5) For each pair of products below, determine which product would have a
higher price elasticity of demand (in absolute value). Refer to the list of determinants in
the lecture slides, point out which determinant is relevant in each case.
a. Drugs for cancer treatment and Lacoste polo shirts
ANSWER:
People need to buy medicine for cancer treatment if they have it and there are no
substitutes for it so the price elasticity of demand is perfectly inelastic.
Lactose polo shirts are products based on a person’s need and it has many alternatives so
the price elasticity of demand is elastic.
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The determinants: necessity (drugs for cancer treatment) and convenience (Lactose polo
shirts).
- The demand curve of drugs for cancer treatment is perfectly inelastic.
- The demand curve of Lactose polo shirts is elastic.
b. Petrol (in the short run) and Petrol (in the long run)
ANSWER:
In the short run, consumers do not have enough time to switch the transportations that use
petrol if the price is higher so the price elasticity of demand can be inelastic. However, in
the long run, consumers have time to choose other options such as electric vehicles,
public transportation and so on. Therefore, in the long run, the price elasticity of demand
for petrol is elastic.
The determinants: time passes
- The demand curve of petrol in the short run is inelastic.
- The demand curve of petrol in the long run is elastic.
c. Petrol and Domino’s Pizza
ANSWER:
Petrol has few substitutes so it is inelastic. While the price elasticity of demand for
Domino’s pizza is elastic because there are many pizza’s brands like Pizza Hut, Pizza
Company and so on.
The determinants: availability of substitutes
- The demand curve of petrol is inelastic.
- The demand curve of Domino’s pizza is elastic.
Pick the following pair of products “Drugs for cancer treatment” and “Lacoste polo
shirts”.
Draw the demand curve for each of them, then compare. What can you say about the
difference in the demand curve between cancer drugs and Lacoste polo shirts? Explain.
ANSWER:
The demand curve for drugs for cancer treatment is vertical because even if prices
change, consumers still need for life. As for the demand curve for Lactose polo shirts
slope down to the right, when the price increases, the quantity demanded decreases and
vice versa.
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ECO10004: ECONOMIC PRINCIPLES

WEEK 4_TUTORIAL QUESTIONS

Applying the mid-point formula:

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