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ECON2103 Tutorial 3

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ECON2103 Tutorial 3

Uploaded by

TWICE FUA GROUP
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© © All Rights Reserved
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ECON 2103 Principles of Microeconomics (L2&L3) - Tutorial Three

Jeremy TO
February 29, 2024

1 Elasticity and its Applications


1.1 Price Elasticity of Demand
• In general, elasticity measures responsiveness. The price elasticity of demand measures how responsive buyers
are to a change in the price of the good.
• Mathematically, it is a units-free measure of the responsiveness of the quantity demanded of a good to a
change in its price when all other influences on a buyer’s plans remain unchanged. The price elasticity of
demand is equal to the absolute value of

%∆ in Quantity Demanded
εd = .
%∆ in Price

• Expand and rearrange the equation:


∆Qd
%∆ in Quantity Demanded Qd × 100% ∆Qd P 1 P 1 P
εd = = ∆P
= × = ∆P
× = ×
%∆ in Price P × 100%
Qd ∆P ∆Qd
Qd Slope of Demand Curve Qd

• If we use Mid-Point Method 0


Q + Qd P0 + P
Qd = d and P =
2 2

1.2 Inelastic and Elastic Demand


• Inelastic Demand: The price elasticity of demand is less than 1, which means the percent- age change in
the quantity demanded is less than the percentage change in price.
• Perfectly Inelastic Demand: The price elasticity of demand is 0 and the good’s demand curve is a vertical
line, which means the quantity demanded remains constant when the price changes.
• Unit Elastic Demand: The price elasticity of demand is equal to 1, which means the percentage change in
the quantity demanded equals the percentage change in price.
• Elastic Demand: The price elasticity of demand is greater than 1, which means the percentage change in
the quantity demanded exceeds the percentage change in price.
• Perfectly Elastic Demand: The price elasticity of demand is infinite, which means the quantity demanded
changes by an infinitely large percentage in response to a tiny price change.

1.3 Total Revenue and Elasticity


• With the exception of a vertical demand curve and a horizontal demand curve, the price elasticity of demand
changes when moving along a linear demand curve.

• At points on the demand curve above the midpoint, the price elasticity of demand is elastic while at points
below the midpoint, the price elasticity of demand is inelastic. At the midpoint, the price elasticity of demand
is unit elastic.
• The total revenue from the sale of a good equals the price of the good multiplied by the quantity sold.

1
• Exercise: Given a linear demand function
P = a − bQd
a a a
Find the elasticity of demand when: P = 0, P = a, P = 2 ,a > P > 2 and 2 > P > 0.
• If demand is elastic, a 1 percent price cut increases the quantity sold by more than 1 percent and total revenue
increases.
• If demand is unit elastic, a 1 percent price cut increases the quantity sold by 1 percent and total revenue
does not change.

• If demand is inelastic, a 1 percent price cut increases the quantity sold by less than 1 percent and total
revenue decreases.

1.4 The Factors that Influence the Elasticity of Demand


• The closeness of Substitutes: The closer and more numerous the substitutes for a good or service, the
more elastic the demand.

• Nature of the goods: Necessities tend to have inelastic demand, whereas luxuries have elastic demands.
• The amount of time elapsed since the price change: The longer the time elapsed since the price change,
the more elastic the demand.
• Definition of the market: Narrowly defined markets tend to have more elastic demand than broadly
defined markets.

1.5 More Elasticities of Demand


1.5.1 Income Elasticity of Demand
• It is a measure of the responsiveness of the demand for a good to a change in the income, other things
remaining the same,
%∆ in Quantity Demanded
εI = .
%∆ in Income
• The income elasticity of demand is positive for normal goods and negative for inferior goods.

1.5.2 Cross Elasticity of Demand


• It is a measure of the responsiveness of the demand for a good to a change in the price of a substitute or
complement, other things remaining the same,

%∆ in Quantity Demanded of Good X


εX,Y =
%∆ in Price of Good Y

• Good X and Good Y are substitutes if the cross elasticity of demand is positive, and they are complements
if it is negative.

2
2 Practice Questions
Problem 1: The demand schedule for computer chips is
Price Quantity demanded
(dollars per chip) (millions of chips per year)
200 50
250 45
300 40
350 35
400 30

(1) What happens to total revenue if the price falls from $400 to $350 a chip and from $350 to $300 a chip? At
what price is total revenue at a maximum?

(2) At an average price of $350, is the demand for chips elastic, inelastic or unit elastic?

(3) At an average price of $250, is the demand for chips elastic, inelastic or unit elastic?

Problem 2: Your price elasticity of demand for bananas is 4. If the price of bananas rises by 5 percent, what is

(1) The percentage change in the quantity of bananas you buy?

(2)The change in your expenditure on bananas?

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Now your income elasticity of demand for bananas is 1 2 . If your income rises by 10 percent,
(3) What is the percentage change in the quantity of bananas you buy?

(4) Is banana a normal good or not? Explain.

Problem 3: Recession Has Led To Spending On Food Falling By 8.5%, Say Researchers Families in Britain,
especially the ones with children, have altered their eating habits in the face of recession. Less is spent on fruit and
vegetables and more on processed foods lacking in nutrition.

Source: The Guardian, November 4, 2013


(1) Given the prices, is the income elasticity of demand for fruit and vegetables positive or negative? Are fruit and
vegetables a normal good or an inferior good? Are processed foods a normal good or inferior good?

(2) Are fruits and vegetables and processed foods substitutes? Explain.

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