Question

1. Baumol and Blinder Chapter 4 Test Yourself # 2, 3 2. Suppose the elasticity of demand equals 2.5. (Hint: write down the formula for ED first.) If the price rises by 10%, what happens to quantity demanded? Be precise! Is this a “large” or “small” change in quantity demanded? If price rises by 10%, will TR rise? Explain with reference to the formula for TR. 3. Suppose the government decided to tax bottled water. Using supply and demand analysis, what do you think will happen to P and to Q? Will Q change a lot or a little? Explain. Is the government “interested” in raising a lot of revenue with this tax? Explain. Book used: Microeconomics Principle and Policy By: William J. Baumol and Alan S. Blinder

Answer 1

Price elasticity of demand is always negative because there is a negative relationship between the price and the quantity demanded.

So, Elasticity of demand = % change in quanttiy demanded/% change in price.

-2.5 = % change in quantity demanded/+10%

-25% = change in quantity demanded. therefore, the change in quantity demanded is decrease of 25%. this is elastic demand.

its a large change in quantity demanded when the price changes by only 10%.

No, the TR will fall with a rise in price because the quantity would fall by a larger fraction and the total revenue which is product of price and quantity would decrease.

Taxing the bottles water would increase the price of the bottled water and decrease the quantity demanded because the tax burden would be put on the consumers.

The Q would decrease by a larger amount as the demand is elastic and the rise in price would result into a larger fall in quantity demanded.

The government would not be able to raise tax revenue as the quantity demanded would fall by a larger proportion than the rise in price, so the revenue would fall rather. the government is more interested in reducing the quantity of bottled water in the market.