Answers to Workshop 3 Markets in Action 1. (a) The price elasticity of demand measures the responsiveness of the quantity demand

Answers to Workshop 3

Markets in Action

1. (a) The price elasticity of demand measures the responsiveness of  the quantity demanded to a change in price.   


      (b) Give the formula for price elasticity of demand. See formula in question 4 below. 
 
 


2. Back in the mid-1990s, the government in the UK announced that for every 10 per cent rise in the price of cigarettes, the demand was likely to fall by 6 per cent.  If this information was correct, what was the value of the price elasticity of demand for cigarettes at the time? –0.6  (= –6%/10%) 
 
 


3. In each of the following pairs, tick which of the two items is likely to have the more elastic demand.  Give reasons for your answer. 


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      (a) Petrol (all brands)  Esso petrol 


There is no close substitute for petrol. If the price of petrol went up, the quantity demanded would fall only slightly, as people would still need fuel for their cars. If the price of Esso petrol went up, however (assuming that the prices of other brands had not changed), people could easily switch to other brands. 
 


      (b) Holidays abroad Bread 


People could easily substitute cheaper holidays, at home or abroad, if the price of foreign holidays rose. The substitutes for bread are less close, and people spend a relatively small proportion of their income on bread. A rise in the price of bread, therefore, is likely to result in only a small fall in the quantity demanded. 
 


      (c) Salt Clothing 


People spend such a small proportion of their income on salt that they could easily afford to pay a higher price – and would probably not even be aware that the price had risen. Do you know the price of a drum of salt?

 


 
 


4. The formula for price elasticity of demand is as follows: 


Proportionate (or percentage) change in quantity demanded

Proportionate (or percentage) change in price 
 


      This can be summarised as: 


Q_d / mid Q_d   P / mid P 
 


      The following table shows the quantity of a product demanded at two different prices: 
 





P	Qd
16 14	25 35

 
 
 


      (a) Calculate the proportionate change in quantity demanded when price falls from £16 to £14.

            (Use the first part of the formula, i.e. Q_d / mid Q_d , to do your calculation.) 


Q_d / mid Q_d = 10/30 = 0.33 
 
 


      (b) Calculate the proportionate change in price when price falls from £16 to £14.

            (Use the second part of the formula, i.e. P / mid P, to do your calculation.) 


P / mid P = –2/15 = –0.13 
 
 


      (c) What is the price elasticity of demand between £16 and £14? 


Q_d / mid Q_d   P / mid P = 0.33/–0.13 = –2.5 
 
 
 


 


 
 


5. The following diagram shows two demand curves that cross at a price of  P₀.  
 
 


      Which of the following statements are true? 


      (a) Curve D₁ is inelastic and curve D₂ elastic. False

   The price elasticity of demand decreases as you move down a straight-line demand ��curve��, so you can only compare elasticity at particular points on the two curves or over particular segments.  
 


      (b) Demand is more elastic between P₀ and P₁ along curve D₂ than along curve D₁ True

There is a bigger change in quantity demanded for the given change in price along curve D₂. 
 


      (c) The price elasticity of demand between P₀ and P₁ in the case of curve D₂ is equal to: 


             Q₂  Q₀                  P₀  P₁

                                             True

               mid Q              mid P 
 


(d) For any given change in price there will be a larger proportionate change in quantity along curve D₁ than along curve D_2.  False

The opposite is true.

 


 
 


6. Fill in the rest of the following table: 


      (For the final column use the formula: Q_d / mid Q_d   P / mid P) 
 





Quantity demanded (000s)	Price (£)	Total  consumer expenditure	Elastic or inelastic demand	Price elasticity of demand
7    9  11  13	13  11    9    7	91  99  99  91	elastic  unit elastic  inelastic	–1.5  –1  –0.67

 
 
 


7. (a) What is the formula for  income elasticity of demand? Q_d / mid Q_d   Y / mid Y

(where Y is income) 


(b) Which of the following would you expect to have a demand which is elastic with respect to income? (There are more than one.) 


            (i) Flour No 


            (ii) Ready-prepared meals for the microwave  Yes 


            (iii) Champagne Yes 


            (iv) Socks  Possibly (if they were designer socks) 


            (v) Designer jeans Yes 


            (vi) Electricity Possibly (if luxury appliances use a relatively large amount of electricity) 


            (vii) Bus journeys No 


            (viii) Insurance Yes