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Chapter 06 - Elasticity
6-1
Chapter 06 - Elasticity
McConnell Brue Flynn 21e
DISCUSSION QUESTIONS
1. Explain why the choice between 1, 2, 3, 4, 5, 6, 7, and 8 “units,” or 1,000, 2,000, 3,000, 4,000,
5,000, 6,000, 7,000 and 8,000 movie tickets, makes no difference in determining elasticity in Table
6.1. LO1
2. What effect would a rule stating that university students must live in university dormitories have on
the price elasticity of demand for dormitory space? What impact might this in turn have on room
rates? LO1
3. The income elasticities of demand for movies, dental services, and clothing have been estimated to
be +3.4, +1, and +.5, respectively. Interpret these coefficients. What does it mean if an income
elasticity coefficient is negative? LO5
Chapter 06 - Elasticity
6-2
4. Research has found that an increase in the price of beer would reduce the amount of marijuana
consumed. Is cross elasticity of demand between the two products positive or negative? Are these
products substitutes or complements? What might be the logic behind this relationship? LO5
5. LAST WORD What is the purpose of charging different groups of customers different prices?
Supplement the three broad examples in the Last Word with two additional examples of your own.
Hint: Think of price discounts based on group characteristics or time of purchase.
REVIEW QUESTIONS
1. Suppose that the total revenue received by a company selling basketballs is $600 when the price is
set at $30 per basketball and $600 when the price is set at $20 per basketball. Without using the
midpoint formula, identify whether demand is elastic, inelastic, or unit-elastic over this price range.
6-3
2. What are the major determinants of price elasticity of demand? Use those determinants and your
own reasoning in judging whether demand for each of the following products is probably elastic or
inelastic: (a) bottled water; (b) toothpaste; (c) Crest toothpaste; (d) ketchup; (e) diamond bracelets; (f)
Microsoft’s Windows operating system. LO1
3. Calculate total-revenue data from the demand schedule in review question 1. Graph total revenue
below your demand curve. Generalize about the relationship between price elasticity and total
revenue. LO2
Answer:
Chapter 06 - Elasticity
6-4
To calculate total revenue, multiply price and quantity. At the price of $5 one unit is sold.
4. How would the following changes in price affect total revenue? That is, would total revenue
increase, decrease, or remain unchanged? LO2
a. Price falls and demand is inelastic.
b. Price rises and demand is elastic.
c. Price rises and supply is elastic.
d. Price rises and supply is inelastic.
e. Price rises and demand is inelastic.
f. Price falls and demand is elastic.
g. Price falls and demand is of unit elasticity.
Chapter 06 - Elasticity
6-5
5. In 2015, Paul Gauguin's painting When Will You Marry sold for $300 million. Portray this sale in
a demand and supply diagram and comment on the elasticity of supply. Comedian George Carlin
once mused, “If a painting can be forged well enough to fool some experts, why is the original so
valuable?” Provide an answer. LO4
6. Suppose the cross elasticity of demand for products A and B is +3.6 and for products C and D is -
5.4. What can you conclude about how products A and B are related? Products C and D? LO5
Answer: The cross elasticity relates the percentage change in quantity to the percentage
PROBLEMS
1. Look at the demand curve in Figure 6.2a. Use the midpoint formula and points a and b to calculate
the elasticity of demand for that range of the demand curve. Do the same for the demand curves in
Figures 6.2b and 6.2c using, respectively, points c and d for Figure 6.2b and points e and f for Figure
6.2c. LO1
Chapter 06 - Elasticity
6-6
Feedback: Consider the following figures taken from the textbook (Figures 6.2a, 6.2b, and
6.2c).
To calculate the elasticity, we use the midpoint formulas. Recall that the elasticity is
percentage change in quantity divided by the percentage change in price. We take the
absolute value to convert the elasticity to a positive number.
Chapter 06 - Elasticity
6-7
2. Investigate how demand elasticities are affected by increases in demand. Shift each of the
demand curves in Figures 6.2a, 6.2b, and 6.2c to the right by 10 units. For example, point a in
Figure 6.2a would shift rightward from location (10 units, $2) to (20 units, $2) while point b would
shift rightward from location (40 units, $1) to (50 units, $1). After making these shifts, apply the
midpoint formula to calculate the demand elasticities for the shifted points. Are they larger or
smaller than the elasticities you calculated in Problem 1 for the original points? In terms of the
midpoint formula, what explains the change in elasticities? LO1
Chapter 06 - Elasticity
6-8
Chapter 06 - Elasticity
6-9
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
If we compare the elasticities in this problem to those found in problem 1, we can see that an
increase in quantity at every price (shift the demand schedule to the right) reduces the
elasticity. The percentage change in quantity is smaller given the higher quantity purchased at
every price.
3. Suppose that the total revenue received by a company selling basketballs is $600 when the price is
set at $30 per basketball and $600 when the price is set at $20 per basketball. Without using the
midpoint formula, can you tell whether demand is elastic, inelastic, or unit-elastic over this price
range? LO2
4. Danny “Dimes” Donahue is a neighborhood’s 9-year-old entrepreneur. His most recent venture is
selling homemade brownies that he bakes himself. At a price of $1.50 each, he sells 100. At a price of
$1.00 each, he sells 300. Is demand elastic or inelastic over this price range? If demand had the same
elasticity for a price decline from $1.00 to $0.50 as it does for the decline from $1.50 to $1.00, would
cutting the price from $1.00 to $0.50 increase or decrease Danny’s total revenue? LO2
Chapter 06 - Elasticity
6-10
Feedback: The total revenue rule implies that demand is elastic when revenue and price
move in opposite directions. In other words, a decrease in price results in an increase in total
revenue. We can use this rule to answer this question.
Consider the following values: At a price of $1.50 each, Danny sells 100. At a price of $1.00
each, he sells 300. Is demand elastic or inelastic over this price range?
We can also answer the following question now: If demand had the same elasticity for a price
decline from $1.00 to $0.50 as it does for the decline from $1.50 to $1.00, would cutting the
price from $1.00 to $0.50 increase or decrease Danny’s total revenue?
5. What is the formula for measuring the price elasticity of supply? Suppose the price of apples goes
up from $20 to $22 a box. In direct response, Goldsboro Farms supplies 1,200 boxes of apples instead
of 1,000 boxes. Compute the coefficient of price elasticity (midpoints approach) for Goldsboro’s
supply. Is its supply elastic, or is it inelastic? LO4
measuring the elasticity of demand. Divide the percentage change in quantity by the
percentage change in price. The only difference is that we do not need to take absolute value
here because the price and quantity will move in the same direction (implying the elasticity is
already positive).
The same interpretation also applies. Supply is elastic if greater than 1, inelastic if less than 1,
and is unit elastic if the elasticity equals 1. Thus, in this case, supply is elastic.
6-11
6. ADVANCED ANALYSIS Currently, at a price of $1 each, 100 popsicles are sold per day in the
perpetually hot town of Rostin. Consider the elasticity of supply. In the short run, a price increase
from $1 to $2 is unit elastic (Es = 1.0). So how many popsicles will be sold each day in the short run
if the price rises to $2 each? In the long run, a price increase from $1 to $2 has an elasticity of supply
of 1.50. So how many popsicles will be sold per day in the long run if the price rises to $2 each?
(Hint: Apply the midpoints approach to the elasticity of supply.) LO4
Feedback: To answer this question we need to use the midpoint formula. Assume we have
the two ordered pairs (Q1,P1) and (Q2,P2).
We can then solve this equation to determine the quantity sold as a result of a price increase.
Consider the following values: At a price of $1 each, 100 popsicles are sold per day in
Rostin. In the short run, a price increase from $1 to $2 is unit elastic (Es = 1.0). So how
many popsicles will be sold each day in the short run if the price rises to $2 each? In the long
run, a price increase from $1 to $2 has an elasticity of 1.50. So how many popsicles will be
sold per day in the long run if the price rises to $2 each?
Chapter 06 - Elasticity
6-12
Copyright © 2018 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
We can do the same exercise for the long run. Here we have the following information.
with the ordered pairs of (100,1) and (Q2,2). Here we need to solve for Q2.
This implies:
Thus, we sell 200 popsicles in the short run and 300 in the long run when price increases
from $1 to $2. (Note, this implies an increase in demand (shift right)).
7. Lorena likes to play golf. The number of times per year that she plays depends on both the price of
playing a round of golf as well as Lorena’s income and the cost of other types of entertainment—in
particular, how much it costs to go see a movie instead of playing golf. The three demand schedules
in the table below show how many rounds of golf per year Lorena will demand at each price under
three different scenarios. In scenario D1, Lorena’s income is $50,000 per year and movies cost $9
each. In scenario D2, Lorena’s income is also $50,000 per year, but the price of seeing a movie rises
to $11. And in scenario D3, Lorena’s income goes up to $70,000 per year while movies cost $11.
LO5
a. Using the data under D1 and D2, calculate the cross elasticity of Lorena’s demand for golf at all
three prices. (To do this, apply the midpoints approach to the cross elasticity of demand.) Is the cross
elasticity the same at all three prices? Are movies and golf substitute goods, complementary goods, or
independent goods?
b. Using the data under D2 and D3, calculate the income elasticity of Lorena’s demand for golf at all
three prices. (To do this, apply the midpoints approach to the income elasticity of demand.) Is the
income elasticity the same at all three prices? Is golf an inferior good?
Chapter 06 - Elasticity
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Feedback: Consider the following values and table: In scenario D1, Lorena’s income is
$50,000 per year and movies cost $9 each. In scenario D2, Lorena’s income is also
$50,000 per year, but the price of seeing a movie rises to $11. And in scenario D3,
Lorena’s income goes up to $70,000 per year while movies cost $11.
Part (a): To calculate the cross elasticity we use the percentage change in quantity of one
good divided by the percentage change in the price of another good. For the current
problem we will look at the percentage in the quantity of golf games divided by the
percentage change in the price of movies.
Here we use the same formula:
Chapter 06 - Elasticity
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To determine if movies and golf are substitute goods, complementary goods, or independent
goods we have the following rule.
If the cross elasticity is negative then the goods are complements. The logic underlying this
rule is as follows. If the price of a movie increases we know that we will see fewer movies.
This implies that the quantity of movies declines. Also, given the negative cross elasticity we
know that golf games decline as the price of a movie increases. This implies that as the price
of movies goes up we consume less movies and golf games. This implies the goods are
complements.
Thus, our answer is golf and movies are complements.
A similar logic applies to substitute goods. If the price of good A increases then the quantity
demanded of good A goes down. If the cross elasticity is positive then this implies the
demand for the good B increases as a result of the price increase for good A. Thus, the
quantity of good A decreases and the quantity of good B increases. This implies good A and
good B are substitutes.
Finally two goods are independent if the cross elasticity is zero. A price change in one good
does not change the quantity of the other good.
Part (b): To calculate the income elasticity we use a similar approach. Here we divide the
percentage change in quantity by the percentage change in income. We do this at every price
for the good.
For our golf example we have the following income elasticities.
Chapter 06 - Elasticity
6-15
Finally we have the ordered pair of (20, 50000) and (50, 70000) at the price of $20 for a
game of golf.
