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Volume 34, Number 2, November 2016
Answers
Question and answer: Using
quantitative skills in exams
Peter Smith
This resource provides answers to the questions set in the article on climate change,
on pp. 26–9 of the November 2016 issue of ECONOMIC REVIEW.
Question 1
Question asked you to interpret a number of elasticity values, which are reproduced here:
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a) is the price elasticity of demand for X, and the value indicates that demand is price inelastic,
as the value of the elasticity is numerically greater than 1. For example, a 10% increase in the
price of X would lead to a 17% decrease in the quantity demand of X, so demand is relatively
sensitive to the price of the good.
b) is a cross-price elasticity. It tells us that if the price of Good A increases by 10%, the quantity
of demanded of Good X would increase by 21%. These goods are strong substitutes.
c) is also a cross-price elasticity, but takes on a negative value. This means that if the price of
Good B were to increase by 10%, the quantity demanded of Good X would fall (by 15%),
suggesting that the two goods are complements.
d) is another cross-price elasticity, but taking a value of zero, suggesting that the demand for
these goods is not connected. A change in the price of Good C has no impact on the quantity
demanded of Good X.
e) is an income elasticity of demand. An increase in consumer incomes results in a fall in the
quantity demanded of Good X, suggesting it is an inferior good. A positive value would have
indicated a normal good.
f)
is an estimate of the price elasticity of demand for Good X, with a very high value indeed
(–5,653). This suggests that demand is almost perfectly elastic, suggesting that the firm is
operating in a perfectly competitive market, having no real control over price.
g) is an elasticity of supply. The low value suggests that an increase in price would induce only a
1% increase in the quantity supplied. The good is in virtually fixed supply.
Question 2
If price increases from £12 to £13, the elasticity is calculated as –0.9, whereas if price increases from
£16 to £17, the elasticity is –1.6.
Notice that the demand curve in the question is a straight line, but the elasticity varies according to the
price at which it is calculated. When the price is relatively high, demand is relatively price elastic, but
when price is relatively low, it is inelastic. This is a feature of any linear demand curve — buyers are
more sensitive to a change in price when price starts high than when it is low.
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Question 3
Output
(units)
10
Fixed
costs
200
Variable
costs
200
Total cost
400
Average
total cost
40
Marginal
cost
25
20
200
400
600
30
30
200
700
900
30
40
200
1,100
1,300
32.5
50
200
1,600
1,800
36
60
200
2,300
2,500
41.7
30
40
50
70
Answers are shown in red. Notice that the ‘marginal’ column is offset from the other rows, reflecting
the fact that it shows the change from one row to the other.
The relationship between the columns is as follows:

Total cost = fixed cost + variable cost

Average total cost = total cost / output

Marginal cost = the change in total cost divided by the change in output
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We could also calculate average variable and average fixed costs. Figure 1 plots these values on a
graph. Notice that marginal cost cuts total average costs at the minimum point of average cost. This is
a mathematical property of these series, and will always be the case. Average variable costs decline
consistently over time, as these costs are spread over a larger quantity of output.
Figure 1 A firm’s costs
This resource is part of ECONOMIC REVIEW, a magazine written for A-level students by subject experts.
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www.hoddereducation.co.uk/economicreview