Tutorial 2
Elasticity
Elasticity 1
• The price of orange falls from 15B to 10B
per kilogram and the quantity demanded
goes from 100,000 to 200,000 kilograms.
Use the midpoint method to find the price
elasticity of demand.
Solution 1
% change in price
15 B – 10 B
X 100 =
(15 B + 10 B)/2
5 X 100 = 40%
12.5
% change in quantity
200,000 – 100,000 X 100 = 100,000 X 100 = 67%
(200,000 + 100,000)/2
150,000
Therefore the price elasticity of demand using the
midpoint method = 67% / 40% = 1.7
Elasticity 2
• At the present level of consumption, 4,000
movie tickets, and at the current price,
120B per ticket, the price elasticity of
demand for movie tickets is 1. Using the
midpoint method, calculate the percentage
by which the owners of movie theaters
must reduce price in order to sell 5,000
tickets.
Solution 2
• By the midpoint
method, the %
change in the quantity
of movie tickets
demanded in going
from 4,000 to 5,000
tickets is
• Since the price
elasticity of demand
= 1 at the current
consumption level, it
will take a 22% drop
in the price of movie
tickets to generate a
22% increase in
quantity demanded
% change in quantity
4,000 – 5,000 X 100 = 1,000
(4,000 + 5,000)/2
4,500
X 100 = 22%
Elasticity 3
• The price elasticity of demand for icecream cone is 1.2 at the current price of
50B per cone and the current consumption
level of 100,000 cones. Calculate the
change in quantity demanded when price
rises by 5B. Calculate % change in price
and % change in quantity demanded.
Solution 3
• Since price rises, we know that quantity
demanded must fall. Given the current
price of 50B, a 5B increase in price
represents a 10% change
• % change in quantity demanded =
Price elasticity = % change in quantity demanded
% change in price
1.2
= % change in quantity demanded
10%
12%
= % change in quantity demanded
Elasticity 4
For each case, choose the condition that
characterizes demand: elastic demand,
inelastic demand, or unit-elastic.
a. Total revenue decreases when price
increase.
Solution 4
a. Elastic Demand. Consumers are highly
responsive to changes in price. For a
rise in price, the quantity effect (which
tends to reduce total revenue) outweighs
the price effect (which tends to increase
total revenue). Overall, this leads to a
fall in total revenue.
Elasticity 4
b. The additional revenue generated by an
increase in quantity sold is exactly offset
by revenue lost from the fall in price
received per unit.
c. Total revenue falls when output
increases.
Solution 4
b. Unit-elastic demand. Here the revenue lost to
the fall in price is exactly equal to the revenue
gained from higher sales. The quantity effect
exactly offsets the price effect.
c. Inelastic demand. Consumer are relatively
unresponsive to changes in price. For
consumers to purchase a given percent
increase in output, the price must fall by an
even greater percent.
Price effect > Quantity effect = revenue increases
Elasticity 5
• For the following goods, what is the
elasticity of demand? Explain. What is the
shape of the demand curve?
• a. Demand by a snake-bite victim for an
antidote
• b. Demand by students for green erasers
Solution 5
• Once bitten by a venomous snake, the
victim’s demand for an antidote is very
likely to be perfectly inelastic because
there is no substitute and it is necessary
for survival. The demand curve will be
vertical, at a quantity equal to the needed
dose.
Solution 5
• Students’ demand for green erasers is
likely to be perfectly elastic because there
are easily available substitutes: Non-green
erasers. The demand curve will be
horizontal, at a price equal to that of nongreen erasers.
Externalities
• What type of externality is described in
each of the following examples?
• Is the marginal social benefit greater than
or equal to the private marginal benefit?
• Is the marginal social cost greater than or
equal to the private marginal cost?
• Without intervention, will there be too little
or too much of this activity?
Externalities
a) Dr. Alice plants lots of colorful flowers in her
front yard
b) Nike, a popular clothing store, opens in a mall,
attracting more shoppers who also visit other
stores.
c) The karaoke shop next to your dorm plays loud
music, keeping you from studying.
d) Dr. Wanwipa buys a large car that consumes a
lot of gasoline.
Solution
• a. This is a positive externality: since other people enjoy
looking at Dr. Alice’s flowers, the marginal social benefit
of looking at the flowers is greater than the marginal
benefit to Dr. Alice of looking at them. As a result, fewer
flowers will be planted than is socially optimal.
• b. This is a positive externality: since additional shoppers
lead to additional business for other stores in the mall,
the store’s decision to locate there confers external
benefits on other stores. The marginal social benefit is
greater than the marginal benefit to NIKE alone. Since
NIKE do not take the external benefit into account in
their decision making, they will open fewer stores in
malls than is socially optimal.
Solution
• c. This is a negative externality: since you cannot study,
an external cost is imposed on you. That is, the marginal
social cost is greater than the marginal cost incurred by
the karaoke shop. Since the karaoke shop does not take
this external cost into account, there will be more music
played (or the music will be louder) than is socially
optimal.
• e. This is a negative externality: the burning of gasoline
produces toxic gases that impose an external cost on
others. The marginal social cost is greater than the
marginal cost incurred by Dr. Wanwipa. As a result, more
people will purchase cars than is socially optimal.
Externalities
• Getting a flu shot reduces not only your chance
of getting the flu but also the chance that you will
pass it onto someone else.
• A. Draw a diagram showing the supply and
demand curves of inoculating different
proportions of the population. Assume that the
marginal cost of each flu shot is constant and is
equal to the marginal social cost, and that the
demand curve is downward sloping.
Externalities
• B. Will the marginal social benefit curve be
higher, lower or the same as the demand
curve? Why? Draw the marginal social
benefit curve into your diagram.
• C. In your diagram show the market
equilibrium quantity and the socially
optimal quantity of flu shots. Is the market
equilibrium quantity of flu shots socially
efficient? Why or why not?
Solution
Solution
• b. The marginal social benefit will be higher than the
marginal benefit of the person inoculated because there
is an external benefit: others who come into contact with
this person now cannot get the flu from him or her. The
curve labeled MSB illustrates this.
• c. The market equilibrium quantity of flu shots is quantity
QMKT at point A, where supply and demand are equal.
The socially optimal quantity of flu shots is quantity
QOPT at point B, where supply and marginal social
benefit are equal. The market-determined quantity is not
efficient: at that quantity, the marginalsocial benefit is
greater than the marginal cost (represented by the
supply curve). That is, immunizing one more person
would bring greater benefit to society, including the
immunized person and those in contact with her, than it
would cost to provide the immunization.