Question

1. Assume Honda estimates the income elasticity of demand for its Accord sedan to be 1.2. If as a result of economic growth in the economy incomes rise by 5%, Honda can expect Accord sales

A. To increase by 12%

B. To increase by 6%.

C. To decline by 5%.

D. To increase by 10%

2. Suppose the price elasticity of the supply of beach front property is 0. An increase in demand for beach front property will

A. Increase the quantity supplied of beach front property.

B. Increase the price of beach front property.

C. Increase the consumer surplus for beach front property.

D. All the above.

3. The following demand schedule is for the quantity of peanut butter sold at various prices. Find the average (ARC) elasticity of demand if price changes from $1 to $3 (in absolute value).

       P Q

    $1.00 50

    $3.00 30

    $5.00 10

    $7.00 1

A. 2.0 B. 1.5 C. 1.25 D. 1.0 E. 0.5   

Answer 1

Answer

1.B.To increase by 6%.

Honda estimates the income elasticity of demand for its Accord sedan to be 1.2. Now, as a result of economic growth in the economy, the incomes rise by 5%.

The income elasticity of demand(_I) for a good is a s follows;

_I = Percentage change in demand for the good / Percentage change in income

The Accord sedan is a luxurious normal good, i.e., if income rises, as a normal good, the demand for Accord will rise. Again as it is a luxurious good, so the percentage rise in its demand will be greater than the percentage rise in income. Now, putting the values of 'income elasticity of demand', and 'income rise', we can conclude that Honda can expect Accord sales to increase by as following;

1.2 = Percentage change in demand for Accord sedan / 5%

Or, percentage change in demand for Accord sedan = (1.2) * 5%

Or, percentage change in demand for Accord sedan = 6%

So, Honda can expect Accord sales to increase by 6%.

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2. B. Increase the price of beach front property.

The price elasticity of the supply of beach front property is 0, i.e., whatever be the price of beach front property, its supply remains constant at the same level. Now, as the supply remains constant, the supply of beach front property will not increase, even if there is an increase in demand for beach front property. As a result, the increase in demand will create an excess demand in the market, which in turn will increase the price of beach front property.

This is illustrated in the following figure;

In the above figure, the quantity of beach front property is measured on the horizontal axis, and the price of beach front property is measured on the vertical axis. The supply of beach front property is fixed at 'Q₀' quantity and thus the supply curve of beach front property is vertical, which is 'SS'. The initial demand curve of beach front property is 'D₁D₁' , and the initial equilibrium price of beach front property is 'P₁'. Now, if the demand for beach front property rises, its demand curve will shift rightward. Let us assume that the new demand curve of beach front property is 'D₂D₂. From the figure we see that for the rise in demand, the price of beach front property rises and the new equilibrium price is 'P₂'.

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3. E. 0.5   

Price	Quantity
$1.00	50
$3.00	30
$5.00	10
$7.00	1

When price(P₁) is $1.00, quantity demanded(Q₁) for peanut butter is 50 units

When price(P₂) is $3.00, quantity demanded(Q₂) for peanut butter is 30 units

Arc elasticity of demand(_d) = Percentage change in quantity demanded / Percentage change in price

In this case, the percentage change in quantity demanded, and the percentage change in price are measured in following way;

Percentage change in quantity demanded = [(Q₂ - Q₁) / {(Q₂ + Q₁) /2}] of 100%

Percentage change in price =  [(P₂ - P₁) / {(P₂ + P₁) /2}] of 100%

Now, putting the values, we get;

Percentage change in quantity demanded = [(30 - 50) / {(30 + 50) / 2}] of 100%

Or, percentage change in quantity demanded = - 20 / (80 / 2) of 100%

Or, percentage change in quantity demanded = - 20 / 40 = - 1/2 of 100%

Or, percentage change in quantity demanded = - 0.5 of 100%

Or, percentage change in quantity demanded = - 50%

Now,

Percentage change in price = [(3 - 1) / {(3 + 1) / 2}] of 100%

Or, percentage change in price = 2 / ( 4/2) of 100%

Or, percentage change in price = 2 / 2 of 100%

Or, percentage change in price = 1 of 100%

Or, percentage change in price = 100%

So, _d = - 50% / 100%

Or, _d = - 1/2

Taking the absolute value, we get,

|_d |= |- 1/2|

Or, _d = 1/2

Or, _d = 0.5

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