Question

1)a) Suppose that a good has a price elasticity equal to 0 (Ed=0). what does this mean? Draw a demand curve to illustrate.

b) What does it mean if a good has a price elasticity equal to1?

2) Briefly explain how each of the following government intervention strategies will affect a given market.

a) a price ceiling on the rental housing market

b) a price floor in the labor market

3) An economist determines that the price elasticity of demand for restaurant meals is 1.25. Interpret this value using the price elasticity of demand formula.

Answer 1

1.

Since the elasticity of demand can be defined as the measurement of the degree of the responsiveness of the quantity demand due to the change in the price level.

a.

Ed = % change in the quantity demand of good X/ % change in the price of good X

So if the Ed=0, then the demand curve will be a vertical line.

It shows that there is no effect of change in the price on the quantity demand.

b.

If price elasticity of demand is 1, then it means the effect of percentage change in the price is equal on the percentage change in the quantity demand.

2.

a.

The price ceiling is a legal maximum price which can be charged by the sellers and it is set below the equilibrium price. The price ceiling imposed by the government leads shortage of goods.

If price ceiling is set below the equilibrium price, then it will be binding and if it is set above the equilibrium price, then it will be not binding.

So when a price ceiling is imposed in the housing market, there will be excess demand of housing due to price ceiling.

All this has been shown in the below diagram.

b.

Since the price floor is the legal minimum price which can be charged and it is set above the equilibrium price. It leads surplus of outputs. A binding price floor is set above the equilibrium price. The example of price floor is minimum wage.

When a price floor is imposed in the labor market, there will excess supply of labor in the labor market due to price floor wage rate which is above the equilibrium wage rate. All this has been shown in the below diagram.

3.

An economist determines that the price elasticity of demand for restaurant meals is 1.25.

Ed= % change in the quantity demand / % change in the price

Since Ed= 1.25, it means that the effect of % change in the price is more on the % change in the quantity demand.

It means when price of meals increases, the quantity demand of the meals decrease in the greater quantity.