Name: Jamal Ahmad, Warda Javed, Arooba Sajid

Reg #: BSP201016, BSP201023, BSP201030

Group: (9)
Date: 19-April-2020
Course: Microeconomics
Section: (1)
Assignment No: (2)
Description: Elasticity and its Application

Submitted to: Dr. Saira Ahmed

Capital University of Science &

Technology
 QUESTION NO:1
A product sells for $100 per unit, and the demand at that price is 10,000 units
per week. The firm increases its price to $110 each and sales fall to 8,000 units
per week. What is the price elasticity of demand for the product, and what
effect will the price rise have on the firm's revenue?

ANSWER
Definition of Price Elasticity of Demand:

A measure of how much the quantity demanded of a

good responds to a change in the price of that good, computed as the percentage change in
quantity demanded divided by the percentage change in price.

Price (P1) of product = $100

Quantity demanded (Q1) = 10,000

After increasing price:

Price (P2) of product = $110

Quantity demanded (Q2) = 8,000

Formula:

( ) / [( )/ ]
Price elasticity of demand = (According to Midpoint Method)
( ) / [( )/ ]

( ) / [( )/ ] .
Price elasticity of demand = = = .
( ) / [( )/ ] .

The price elasticity of demand for the product is 2.3 which is greater than 1, so the demand
would be elastic.

Explanation:

Price elasticities of demand are sometimes reported as negative numbers. According to book we
follow the common practice of dropping the minus sign and reporting all price elasticities of
demand as positive numbers. (Mathematicians call this the absolute value)
Graph:

Total Revenue:

The amount paid by buyers and received by sellers of a good, computed as the
price of the good times the quantity sold.

P = $100 and Q =10,000, total revenue is $100 x 10,000 or 1,000,000.

Graph:

Effect of Price Rise on Firm’s Revenue:

Effect of Price Rise on Firm’s Revenue:

The demand curve is elastic. In this case, an increase in the price leads to a decrease in quantity
that is proportionately larger, so total revenue decreases. Here an increase in the price from
$100 to $110 causes the quantity demanded to fall from 10,000 to 8,000. Total revenue falls
from 1,000,000 to 880,000.

QUESTION NO:2
A butcher sells beef and lamb only. It is observed that when the price of beef
raises by 15% the demand for lamb increases by 10%.

What is the cross price elasticity for lamb against the price of beef?

ANSWER
Definition of Cross-Price Elasticity of Demand:

A measure of how much the quantity

demanded of one good responds to a change in the price of another good, computed as the
percentage change in quantity demanded of the first good divided by the percentage change in
price of the second good.

Formula:

Cross-price elasticity of demand =

Putting values in Formula:

Cross-price elasticity of lamb = = = 0.66

So the cross-price elasticity of lamb against beef is 0.66.

QUESTION NO:3
How does pricing influence aggregate planning?

a) Price elasticity has no effect in influencing demand patterns.

b) Decreased price elasticity is more effective in influencing demand
patterns.
c) Greater price elasticity is more effective in influencing demand patterns.
d). increased price elasticity is less effective in influencing demand patterns.

ANSWER
(c) is correct.

Greater price elasticity is more effective in influencing demand patterns.

Explanation:

More price elasticity means more excellent responsiveness of the quantity

demanded that is more change or fluctuations in demand for the commodity.
 QUESTION NO:4
Explain the changes in revenue for different elasticity values by completing the
table below

ANSWER

rice elasticity Price change Impact on firm's Explanation

value revenue

Elastic Increase Fall When the demand is elastic (a price elasticity

greater than 1), price and total revenue move in
opposite directions: If the price increases, total
revenue decreases.

Elastic Decrease Rise When the demand is elastic (a price elasticity

greater than 1), price and total revenue move in
opposite directions: If the price decreases, total
revenue increases

Inelastic Increase Rise When the demand is inelastic, an increase in

price leads to decrease in quantity demanded, so
the total revenue will rise.

Inelastic Decrease Fall When the demand is inelastic, a decrease in price

leads to increase in quantity demanded, so the
total revenue will fall.

QUESTION NO:5
Explain:

a) Cross elasticity with reference to examples.

b) Elasticities at the points (0,<1, >1,1, infinity)
c) Substitutes and Complements
 ANSWER
(a) Cross Price Elasticity of Demand:

A measure of how much the quantity demanded of one

good responds to a change in the price of another good, computed as the percentage change in
quantity demanded of the first good divided by the percentage change in price of the second
good.

Formula:

Cross-price elasticity of demand =

Example of Coffee and Tea (Substitutes):

The cross elasticity of demand for substitute goods is always

positive because the demand for one good increases if the price for the other good increases. For
example, if the price of coffee increases, the quantity demanded for tea increases as consumers switch to
a less expensive yet substitutable alternative vice versa.

Example of Hamburgers and Hot Dogs (Substitutes):

As we discussed in Ch 4, substitutes are goods that are

typically used in place of one another, such hamburgers and hot dogs. An increase in hot dogs
prices induces people to grill hamburgers instead. Because the prices of hot dogs and the
quantity of hamburgers demanded move in the same direction, the cross-price elasticity is
positive.

Example of Computers and Software (Complements):

Conversely, complements are goods that are typically

used together, such as computers and software. In this case, the cross-price elasticity is
negative, indicating that an increase in the price of computers reduces the quantity of software
demanded.

(b) Elasticities at the points (0, <1, >1, 1, infinity):

Elasticities of Demand:
Explanation: Demand is perfectly inelastic, and the demand curve is vertical. In this case,
regardless of the price, the quantity demanded stays the same.
Explanation: As the elasticity rises, the demand curve gets flatter and flatter as shown in the
graph.

Explanation: As the elasticity rises, the demand curve gets flatter and flatter as shown in the
graph.

Explanation: As the elasticity rises, the demand curve gets flatter and flatter as shown in the
graph.
Explanation: Demand is perfectly elastic. This occurs as the price elasticity of demand
approaches infinity and the demand curve becomes horizontal, reflecting the fact that very
small changes in the price lead to huge quantity demanded.

(b) Elasticities at the points (0, <1, >1, 1, infinity):

Elasticities of Supply:
(c) Substitutes and Complements:

Substitutes:

Two goods for which an increase in the price of one leads to an increase in the
demand for the other.

Example: Coke and Pepsi, iPhone and Galaxy S series, Nike and Adidas are the few examples of
substitute goods. If price of Coke increases, demand for Pepsi should increases because many
Coke consumers will switch over to Pepsi. Similarly, prices of iPhone and Galaxy S affect their
mutual demand. Given that there are many fan boys who will reprioritize their spending to
afford an iPhone even after the price increase; many rational consumers will weight their
preference for one product over the other and the premium they are willing to pay.

Suppose that the price of frozen yogurt falls. The law of demand says that you will buy
more frozen yogurt. At the same time, you will probably buy less ice cream. Because ice cream
and frozen yogurt are both cold, sweet, creamy desserts, they satisfy similar desires.

Complements:

Two goods for which an increase in the price of one leads to a decrease in the
demand for the other.

Example: iPhone and iPhone skins, air travel and hotels, etc. are examples of complementary
goods i.e. goods that are used/consumed together. If iPhone becomes expensive and its
quantity demanded decreases, you would expend the demand for iPhone covers to drop too and
vice versa. It follows that demand for a product is to some extent dependent on the price of its
complementary goods.

Suppose that the price of hot fudge falls. According to the law of demand, you will buy
more hot fudge. Yet in this case, you will likely buy more ice cream as well because ice cream
and hot fudge are often used together. Other examples of complementary goods include cars
and gasoline, Big Mac and McFries, coffee and cheesecake, etc.

QUESTION NO:6
Explain income elasticity of demand with reference to example.
 ANSWER

Definition of Income Elasticity of Demand:

It is defined as the ratio of the change in quantity

demanded over the change in income.

Example: If a person experiences a 20% increase in income, the quantity demanded for a good
increased by 20%, then the income elasticity of demand would be 20%/20% = 1

Types of Income Elasticity of Demand:

There are five types of income elasticity of demand:

1. High: A rise in income comes with bigger increases in the quantity demanded.
2. Unitary: The rise in income is proportionate to the increase in the quantity demanded.
3. Low: A jump in income is less than proportionate than the increase in the quantity
demanded.
4. Zero: The quantity bought/demanded is the same even if income changes.
5. Negative: An increase in income comes with a decrease in the quantity demanded.
Calculation:

The income elasticity of demand is calculated by taking a negative 50% change in

demand, a drop of 5,000 divided by the initial demand of 10,000 cars, and dividing it by a 20%
change in real income- the$10,000 change in income divided by the initial value of $50,000. This
produces an elasticity of 2.5, which indicates local customers are particularly sensitive to
changes in their income when it comes to buying cars.

Explanation:

 Income elasticity of demand is an economic measure of how responsive the

quantity demand for a good or service is to a change in income.
 The formula for calculating income elasticity of demand is the percent change in
quantity demanded divided by the percent change in income.
 Business uses the measure to help predict the impact of a business cycle on sales.
 QUESTION NO:7
Elasticity can be calculated and a range of values found. What do they show?

ANSWER

Key Terms:

 Elastic: Demand for a good is elastic when a change in price had relatively large effect
on quantity of a good demanded.
 Unit Elastic: Demand for a good is unit elastic when the percentage change in quantity
demanded is equal to the percentage change in price.
 Inelastic: Demand for a good is inelastic when a change in price has a relatively small
effect on the quantity of a good demanded.

Price Elasticity of Demand (PED):

The price elasticity of demand (PED) is a measure that captures

the responsiveness of a good’s quantity demanded to a change in its price. More specifically, it
is the percentage change in quantity demanded in response to a one percent change in price
when all other determinants of demand are held constant.

The formula for the coefficient of PED is:

PED = % change in quantity demanded / % change in price.

Explanation (Range):

The numerical values for the PED coefficient could range from zero to infinity.
In general, the demand for a good is said to be inelastic when the PED is less than one.

Unit Elastic:

A PED coefficient equal to one indicates demand that is unit elastic; any change in
price leads to an exactly proportional change in demand (i.e. a 1% reduction in demand would
lead to a 1% reduction in price).
Perfectly Inelastic Demand:

A PED coefficient equal to zero indicates perfectly inelastic demand.

This means that demand for a good does not change in response to price.

Graphical Representation:

Perfectly inelastic demand is graphed as a vertical line and indicates

a price elasticity of zero at every point of the curve. This means that the same quantity will be
demanded regardless of the price.

Perfectly Elastic Demand:

Demand is said to be perfectly elastic when the PED coefficient is equal

to infinity. When demand is perfectly elastic, buyers will only buy at one price and no other.
Graphical Representation:

Perfectly elastic demand is represented graphically by a horizontal

line. In this case the PED value is the same at every point of the demand curve.

Price Elasticity of Demand and Revenue:

PED is based off of percent changes, the starting

nominal quantity and price matter. At low prices and high quantities, the PED is therefore more
inelastic. For example,
ple, a drop in the price of $1 from a starting price of $100 is a 1% drop, but if
the starting price is $10, it is a 10% drop. Similarly, at high prices and low quantities, PED is
more elastic.
PED is based off of percent changes, so the starting nominal values of price and quantity are
significant.