Assignment 6: Elasticity of Demand and Supply
Reading: Handout
Due Date:
March 21, 2004 by 6:00 PM
General Instructions:
The homework assignment is designed to help you understand the material. Some of the
questions are easy, others are more difficult. You are expected to complete the
assignment in your group without help from other class members or any of the faculty.
Once you have answered all the questions, please send them as an attachment to me at the
following e-mail address: Mary_Bumgarner@coles2.kennesaw.edu. Your grade will be
determined by the accuracy and completeness of your answers as well as the quality of
your presentation.
Principles to be Learned
Price Elasticity of Demand
1.
Price elasticity of demand is the percentage change in quantity demanded divided
by the percentage change in price.
2.
Price elasticity of demand is negative, but economists use its absolute value.
3.
When price elasticity of demand is greater than one, demand is elastic. When
price elasticity is less than one, demand is inelastic. When price elasticity of
demand is equal to one, demand is unit elastic.
4.
The determinants of price elasticity of demand are the availability of substitutes,
the relative importance of the good in the budget, the time to adjust to price
changes, and whether the good is a necessity or a luxury.
5.
Changes in total revenue caused by changes in price reflect whether the price
elasticity of demand is elastic, inelastic, or unit elastic. When goods are price
elastic, price and total revenue move in opposite directions. When goods are
price inelastic, price and total revenue move in the same direction, and when
goods are unit elastic, changes in price do not change total revenue.
Elasticity of Supply
1.
The sensitivity of quantity supplied to changes in price is known as the price
elasticity of supply.
2.
Since the supply curve generally slopes up, price elasticity of supply will be a
positive number.
3.
When the elasticity of supply is greater than one, supply is elastic. When the
elasticity of supply is less than one, supply is inelastic. When the elasticity of
supply is equal to one, supply is unit elastic.
4.
The determinants of supply elasticity are the substitutability of resources in
production and the passage of time.
Technical Details to be Mastered
1.
2.
3.
Learn how to compute the elasticity coefficient.
Learn how to use the elasticity coefficient to solve for the percentage change in
quantity demanded or the percentage change in price.
Learn how to graphically represent different elasticities of demand and supply.
Assignment:
1.
Define price elasticity of demand.
2.
When economists say the price elasticity of demand for apples is 2, what do they
mean? When they say the price elasticity of demand for apples is 0.5, what do
they mean?
3.
List the determinants of a product’s price elasticityof demand? Use the
determinants of price elasticity of demand to determine the likely coefficient of
elasticity for the following products:
a.
Tickets to watch gymnastics at the Olympics
b.
Corn flakes
c.
Tickets to a popular movie.
d.
An apartment in Atlanta
e.
Heroin
f.
Cigarettes
g.
A ride downtown on MARTA
h.
A glass of water
i.
A diamond bracelet
j.
A paper clip
4.
When the wheat harvest fell by 10%, wheat prices went up by 40%. What is the
elasticity coefficient for wheat?
5.
Given the following elasticities and changes in price, determine by how much and
in what direction total revenue changes as a result of the price change.
a.
The elasticity of demand for wheat is 0.25 and wheat prices increase by
20%.
a.
b.
c.
d.
The elasticity of demand for bicycles is 1.5 and bicycle prices increase by
15%.
The elasticity of demand for cigarettes is 0.05 and cigarette prices increase
by 10%.
The elasticity of demand to ride on MARTA is 2 and MARTA prices
increase by 25%.
The elasticity of demand to attend one of the state colleges is 0.9 and
tuition increases by 5%.
5.
The New York Times reported (Feburary 17, 1996, p.25) that subway ridership
declined after a fare increase: “There were nearly four million fewer riders in
December 1995, the first full month after the price of a token increased 25 cents
to $1.50, than in the previous December, a 4.3 percent decline.”
a.
Use these data to estimate the price elasticity of demand for subway rides.
b.
According to your estimate, what happens to the Transit Authority’s
revenue when the fare rises?
c.
Based on your estimate, how would you advise the local MARTA
authorities the next time they propose a fare increase?
d.
Why might your estimate of the elasticity be unreliable?
e.
Why was the comparison made between the months of December 1995
and December 1996 rather than December 1996 and November 1996?
f.
What do you predict will happen to ridership as time passes? Why?
6.
Define elasticity of supply.
7.
When economists say the price elasticity of supply for apples is 2, what do they
mean? When they say the price elasticity of supply for apples is 0.5, what do they
mean?
8.
List the determinants of a product’s elasticity of supply? Use the determinants of
supply elasticity to determine the likely elasticity of the following products:
a.
Pick-up trucks
b.
Corn Flakes
c.
Gasoline
d.
An apartment in Atlanta
e.
Heroin
f.
Cigarettes
g.
Wheat
h.
Iced tea at a lunch counter.
9.
Beachfront resorts have an inelastic supply and automobiles have an elastic
supply. Suppose that a rise in population doubles the demand for both products
(that is, the quantity demanded at each price is twice what it was).
a.
What happens to the equilibrium price and quantity in each market?
b.
Which product experiences a larger change in price?
c.
Which product experiences a larger change in quantity?
d.
10.
What happens to total consumer spending on each product?
Because better weather makes farmland more productive, farmland in regions
with good weather conditions is more expensive than farmland in regions with
bad weather conditions. Over time, however, as advances in technology have
made all farmland more productive, the price of farmland (adjusted for overall
inflation) has fallen. Use the concept of elasticity to explain why productivity and
farmland prices are positively related across space but negatively related over
time.
Supply, Demand and Elasticity Application
Objective:
To improve your understanding of price elasticity of demand and to practice applying this
concept to the real world.
Instructions:
Write your answers to the questions that follow each paragraph. These questions are
based on the article entitled "In Gloucester, a Painful Lesson: Net Gains Aren't Forever,"
Washington Post, 8/21/96.
1.
What does the statement below imply about the price elasticity of demand for
haddock?
"For decades, fishermen here operated under the assumption that it almost always was
better to catch more haddock than less. This was not as self-evident as it may seem: After
all, if too many haddock were landed, it could drive down the price so much that
fishermen would make less money. But over time, fishermen discovered, no matter how
many fish they caught, any decline in price was more than offset by the beneficial effect
of increased volume."
2.
Is the following information consistent with your answer to number (1)
above? Explain.
"Stanley Wang, an economist with the National Marine Fisheries Service here, studied
the relationship between haddock supply and prices between 1974 and 1984. Wang found
that for every 2 percent increase in supply, there had been, on average, a 1 percent
decrease in price."
3.
Does the fact that the price elasticity of demand for haddock "fell
comfortably in the middle" make the italicized portion of the following statement
true? Explain.
"Economists have noted that price elasticity, varies from product to product, depending
on how vital the item is to consumers and whether suitable substitutes are available. In
the case of some goods, such as gasoline and patented drugs, demand is thought to be
relatively inelastic or insensitive to price changes. For other goods -- such as vacation
sets on airlines -- changes in price often result in noticeable changes in demand. But,
haddock fell comfortably in the middle. And for Gloucester's haddock fishermen, that
meant that the market would allow them to earn more money by bringing in more
fish."
4.
Is the following event what you would expect given your previous assessment
of the price elasticity of demand? Explain.
"When a settlement gave Canada the most bountiful portion of the Bank, the Gloucester
fishermen suddenly were confronted with the unfamiliar downside of the elasticity
equation -- as haddock landings declined, prices would rise, but only enough to offset
half the lost volume."
5.
Use the concept of price elasticity of demand as well as the logic of the
demand and supply model to analyze the following paragraph:
"Eventually, half the lost volume turned out to be optimistic, thanks to the arrival in
significant numbers of foreign processors. In the days when prices were well below $1
per pound, it always had been more economical for foreign producers to freeze their
haddock and transport them cheaply in large container ships to customers around the
world. But once the price of fresh haddock reached $1 per pound, an important tipping
point was reached: Foreign processors saw the possibility that they could make more
money selling their product fresh in the United States."