Question

1). Calculate the appropriate elasticity coefficient in each of the following cases using the relevant formula outlined in this chapter.

1. A drop in the price of hybrid cars from $25,00 to $20,000 causes purchases of gasoline powered cars to fall from 1 million to 750, 0000 per year.

2. Monthly purchases of smartphones rise from 15,000 to 17,500 per year when the average price of smartphones decreases from $500 to $400.

3. A fall in the average consumer incomes from $80,000 to $50,000 raises weekly purchases of canned sardines from 2000 to 3000 cans.  

2). Identify whether demand in the case of the following products is likely to be inelastic, elastic or unit elastic

1. A luxury item with many close substitutes
2. An item that represents a large portion of consumers incomes and has many close substitutes
3. A necessity whose demand is being viewed in a short time frame
4. A luxury item that represents a large portion of consumers’ incomes

3). Calculate the numerical value of cross elasticity in each of the following situations using the mid- point method. In each case identify whether the two products are substitutes or complementary products.

1. The price Julia pays each month for access to internet decreases from $80 to $40, causing the quantity demanded of e-magazines she reads on her computer to rise from 3 to 5.

2. The quantity demanded of do-it – yourself hair- cutting sets increase from 5,000 to 10,000 when the average price of hairstylist’s cut rises from $40 to $60 per hour.

3. A fall in the average price of smartphones from $600 to $400 increases purchases of smartphone apps from 1 million to 3 million per month.

4). Calculate the numerical value of income elasticity in each of the following situations using the midpoint approach, and identify if the product is normal or inferior product.

1. Purchases of automobiles rise from 2 million to 3 million when the average consumer income per year increases from $50,000 to $70,000.
2. A fall in average consumer incomes per month from $3,000 to $2,800 leads to a drop in visits to massage therapists from 120,00 to 100,000

5). Calculate the numerical value of the price elasticity of supply I each of the following situation using midpoint method

1. A rise in the price of wheat from $300 to $350 per metric tonne increases the amount supplied by wheat farmers from 8 million to 9 million tonnes.

2. The amount of farmed salmon sold drops from 2 million to 1 million kilograms when the price of salmon falls from $8 to $ 7.50.

3. When the price of oranges rises from 2 million to 3 million per kilogram, the annual amount supplied rises from 2 million to 4 million kilograms.

Answer 1

Cross-price elasticity of demand for gasoline cars

Cross price elasticity is calculated by dividing the % change in quantity demanded of good A by the % change in price of good B.

% change in quantity demanded of gasoline cars

New quantity =750,000 gasoline cars per year

Old quantity=1,000,000 gasoline cars per year

= ((750,000 – 1,000,000)/1,000,000)=250,000/1,000,000=2.5%

% change in price of hybrid cars

New price =$20,000

Old price= $25,000

= ((20,000 – 25,000)/25,000)=5,000/25,000=20%

Cross-price elasticity of demand for gasoline cars=

% change in quantity demanded of gasoline cars/% change in price of hybrid cars

=2.5%/20%=0.125

Price elasticity of demand (PED)= % change in quantity demanded /% change in price of the good.

Price elastic of demand for smartphones

Old quantity =   15,000 smartphones          Old price= $500 per smartphone

New quantity = 17,500 smartphones          New price $400 per smartphone

% change in quantity demanded = ((New quantity-old quantity)/old quantity)) x 100

% change in quantity demanded= ((17,500-15,000)/15,000)) x100

                                                         =(2,500/15,000) x100

                                                       = 16.67%

% change in price = ((New price-old price)/old price)) x 100

                                 =(($400-$500)/500) x100

                                 = (-100/500) x 100

                                 = -20%

Price elasticity of demand = 16.67%/-20%=-0.83. PED is 0.83. PED is inelastic as it is <1. Sign does not matter.

Income elasticity of demand

Income elasticity of demand tells us how the demand for a good changes due to change in income, other things remaining the same.

Income elasticity of demand for canned sardines

% change in quantity demanded/% change in consumers income

% change in quantity demanded:

Old quantity =   2,000 cans        

New quantity = 3,000 cans          

% change in quantity demanded = ((New quantity-old quantity)/old quantity)) x 100

% change in quantity demanded= ((3,000-2,000)/2,000)) x100

                                                         =(1,000/2,000) x100

                                                       = 50%

New income= $80,000         Old income = $50,000

% change in income = ((New income-old income)/old income)) x 100

                                 =(($80,000-$50,000)/$50,000) x100

                                 = ($30,000/$50,000) x 100

                                 = 60%

Income elasticity of demand= 50%/60%=0.83