Micro Elasticity Answers 1 WCC 1) For each of the following price elasticities of demand, indicate in the second column whether demand for the good would be categorized as elastic, inelastic, perfectly elastic, perfectly inelastic, or unit elastic. In the third column, indicate whether increasing the price (within this elasticity range) would increase or decrease revenue. Value 2.5 1.0  0.8 Category Elastic Unit elastic Perfectly elastic Inelastic Change in revenue Decrease No change Decrease to zero Increase 2) Predict what will happen to the price elasticity of demand if the following events take place. Event More or less elastic? The demand curve shifts out Less You slide down a linear demand curve Less The demand curve becomes more vertical More 3) Rank the following goods in order of increasing (from negative to positive) cross‐price elasticity of demand with coffee. Remember that the sign is important with cross‐price elasticities. Explain your reasoning in each case in one or two sentences. Ranking: Tea > Cola > Bleach > Cream Bleach: The cross‐price elasticity will likely be zero as there is no real relationship between bleach and coffee. Tea: These two goods are substitutes. Therefore the cross price elasticity will be positive. Since they are fairly close substitutes, the cross‐price elasticity will also likely be relatively large. Cream: Coffee and cream are complements. Therefore the cross‐price elasticity will be negative. As they are close complements, it is likely to be highly negative. Cola: Coffee and cola are substitutes. As they are not quite as close as coffee and tea, the cross‐price elasticity will be positive, but smaller. Price
A
40
B
30
C
20
D
10
Demand
60 70
80
90
Quantity
4) For the graph above, calculate the price elasticity of demand in the following instances. (Show your calculation) a. A to B [(70‐60)/(30‐40)]*[(40+30)/(60+70)] = 0.5384 b. C to D [(90‐80)/(10‐20)]*[(20+10)/(80+90)] = 0.1765 5) Indicate for each pair of goods, which good likely has a higher price elasticity of demand. In one or two sentences, explain why. a. Dodge Caravan/Minivans in general – Dodge Caravan: There are more substitutes for the Dodge caravan than for the entire class of minivans. b. Electricity/Amusement park admissions – Amusement parks: Electricity tends to be a necessity. Changes in its price do not lead to large changes in quantity demanded. Amusement park visits, however, are luxuries. 6) Cigarettes currently sell for $5 a pack in Aksarben. One million packs are sold each day. A state legislator there suggests implementing a sales tax of $1 per pack, estimating that this will raise $1 million per day in tax revenue for the state. What do you think about this estimate? The estimate may not be far off, but it is too high. Though demand for cigarettes may be fairly inelastic (many smokers are addicted after all), some will quit or cut back as the price rises resulting in revenues somewhat lower than $1 million.