Chapter 5

Question 1

2. Explain the differences among elastic, inelastic, and unit elastic demand.

Answer 1

• Elastic demand: ED > 1
– Quantity demanded is relatively sensitive to price changes
• Inelastic demand
– ED between 0 and 1
– Quantity demanded is relatively insensitive to price changes
• Unit elastic demand: ED = 1
– Quantity demanded changes by the same percentage as the price

Question 2

3. Explain why elasticity is not constant, but rather varies along a straight-line demand curve.

Answer 2

• Straight-line demand curve
– Demand becomes less elastic (ED gets smaller)
• As we move downward and rightward
– Slope of demand is constant

Question 3

4. Describe how price elasticity of demand helps us predict how total revenue will change in response to a change in price.

Answer 3

• Total revenue (TR = P ˣ Q)
– Price per unit (P) times quantity (Q)
– The area of a rectangle with height equal to price and width equal to quantity demanded
• A price increase
– Inelastic demand, ED 1, then TR ↓
– Unit elastic demand, ED = 1, then TR doesn’t change

Question 4

5. List the determinants of price elasticity of demand and explain the effects of changes in these determinants.

Answer 4

•	Availability of substitutes
–	Close substitutes are available for a product
–	More elastic demand
•	Necessities versus luxuries
–	Necessities tend to have less elastic demand than luxuries
•	Importance in buyers’ budgets
–	Larger proportion of families’ budgets
–	More elastic demand

Question 5

6. Use the concept of income elasticity of demand to identify normal goods and inferior goods.

Answer 5

Postive elasticity = normal good

Negative elasticity= inferior good

Question 6

. Use the concept of cross-price elasticity of demand to identify pairs of complements and substitutes.

Answer 6

1. The percentage change in the quantity demanded of one good (X)
   i. Caused by a 1 percent change in the price of another good (Z)
2. If > 0 → substitutes
3. If complement

Question 7

9. List the determinants of price elasticity of supply and explain the effects of changes in these determinants.

Answer 7

• Easier to find alternatives in production
– The more elastic the supply
• The narrow the market definition
– The more elastic the supply
• The longer the time horizon
– The more elastic the supply
• Long-run supply elasticities are greater than short-run supply elasticities

Question 8

10. Explain what it means for demand or supply to be perfectly elastic or perfectly inelastic

Answer 8

•	Perfectly inelastic demand
–	ED = 0
–	Vertical demand curve 
•	Perfectly (infinitely) elastic demand 
–	ED approaching infinity
–	Horizontal demand curve