Question

When personal computers were first introduced in the 1980s, their price exceeded $5000. Since then, the price has decreased dramatically. Use demand and supply analysis to explain the price reduction of computers. What effect did the price reduction have on the quantity of computers demanded?

Suppose that researchers estimate that for very 1-percent change in the price of computers, the quantity demanded will change by 2.5 percent. Describe the price elasticity of demand for computers. What if researchers estimate that the quantity demanded for computers will change by 0.5 percent in response to a 1-percent change in price?

Assume that the price elasticity of demand for corn is 0.6 and the farmers have a record harvest-corn production is higher than ever. What will happen to their total revenue received by farmers?

Answer 1

(1) Over time, demand for computers is rising, shifting demand curve rightward and increasing their price and quantity. At the same time, technological improvements lower cost of production, so supply is rising, shifting supply curve rightward, decreasing price and increasing quantity. The rightward shift in supply curve is higher in magnitude than the rightward shift in demand curve, therefore as the net effect, price has decreased. Quantity has increased.

In following graph, D0 & S0 are initial demand & supply curves intersecting at point A with initial price P0 and quantity Q0. As demand rises, D0 shifts to D1, and as supply rises, S0 shifts to S1, intersecting D at higher price P1 and higher quantity Q1.

(2) Price elasticity = % Change in quantity demanded / % Change in price = 2.5% / 1% = 2.5

(3) Price elasticity = % Change in quantity demanded / % Change in price = 0.5% / 1% = 0.5

(4) Since absolute value of elasticity is 0.6 which is less than 1, demand is inelastic. With inelastic demand, increase in quantity will be less than the decrease in price. Therefore, total revenue will increase.