Question

1. You win $10,000 in a lucky draw. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5% interest. What is the opportunity cost of spending the $10,000 now?

Two drivers – Joan and Rob – each drive up to a gas station. Before looking at the price, each places order. Joan says, “ I’d like 40 litres of gas.” Rob says, “I’d like $40 worth of gas.” What is each driver’s price elasticity of demand?

Answer 1

Ans 1. The opportunity cost of spending $10000 now is the 5% interest forgone on this amount which would have been earned if the money was kept in the bank account for an year. So, opportunity cost of spending $10000 now = 0.05*10000 = $500

Ans 2. Price elasticity of demand = %Change in Quantity demanded/ %change in price of the good

So, for Joan, his consumption of gas is independent of the price level because he ordera the gas in litres irrespective of the price of the gas. So, a change in price of gas won't change the quantity demanded of gas by Joan, thus, his price elasticity of demand is zero i.e. perfectly inelastic.

And for Rob, his consumption of gas is in monetary terms i.e. irrespective of the proce of the gas he will buy only $40 worth of gas. This means that an the quantity demanded of gas by Rob is extremely sensitive to the price of gas. So, his price elasticity of demand is unitary elastic i.e. increase in price gas will not change the total expenditure he kakes on gas. Thus, price elasticity of demand is 1.

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