5 Price elasticity of demand and supply

Chapter Five Price elasticity of demand and supply

Self-assessment Questions

5.1 The percentage change in price is +40%, and the percentage change in quantity demanded is
-30%. This means that Ed = -0.75

5.2 NO! We do not know if demand is elastic or not. This is because there is no information on the
percentage change in price and quantity demanded. We cannot say demand is elastic just by
looking at the absolute change in quantity.

5.3(a) John’s quantity demanded decreases by 33.3%. Hence, his demand is elastic (Ed >1).

Mary’s quantity demanded remains unchanged. Hence, her demand is perfectly inelastic
(Ed =0).

5.3(b) Mary does not behave according to the law of demand. This is because her quantity
demanded does not drop with the increase in price.

5.4 Total revenue on Tuesdays will increase. When demand is elastic, the percentage increase in
quantity demanded will be greater than the percentage drop in price. As a result, the gain in
revenue from a larger quantity demanded will be greater than the loss in revenue from lowering
the price.

5.5 His demand for movie shows is unitarily elastic. This is because his expenditure remains
unchanged no matter how the price changes.

5.6 Form 1 students’ elasticity of demand is lower because

a) They do not have any substitutes. As new comers, they need new uniforms.

Form 5 students can use their old uniforms as substitutes.

b) Their uniforms can be used for a much longer period, so that even if the price of uniforms
is increased, they will still buy new uniforms; their quantity demanded will not drop.

Form 5 students’ uniforms can be used for one more year. If the price is increased, they will
stick to their old uniforms and reduce their quantity demanded for new uniforms.

5.7 The percentage change in price is +10%. The quantity supplied increases by 20%. This means
that the price elasticity of supply is 2.

5.8 The first statement is wrong! Elasticity of supply is not measured in terms of the absolute
changes in price and quantity supplied.

The second statement is wrong! Supply is inelastic if the percentage change in price is larger
than the percentage change in quantity supplied.

5.9(a) The observation does not indicate that the elasticity of demand for umbrellas is -1.5. This is
because during rainy days, there is an increase in demand, not quantity demanded, for
umbrellas.

5.9(b) The observation indicates that the elasticity of supply of umbrellas is 1.5. The increase in
New Introductory Economics 3rd Edition 11 © Pearson Education Asia Limited 2003
Suggested Solutions
 5 Price elasticity of demand and supply

demand results in an increase in price, leading to an increase in quantity supplied.

Multiple Choice Questions

1 B 2 D 3 C 4 B 5 C
6 A 7 C 8 C

1 During peak hours, the cross harbour tunnel company has reached its maximum capacity. Even if
the price is increased, it would be impossible for it to increase the quantity supplied.

3 If demand is elastic, an increase in price will result in a drop in total revenue.

From the diagram, we know that when price is increased, from P2 to P1, total revenue would drop.

4 The percentage increase in price is 20%. If demand is inelastic, the quantity demanded will drop
by less than 20%. This means that the quantity demanded will drop by less than 40 units.

7 A good harvest will result in an increase in supply, which lowers price. If demand is inelastic, the
drop in price will result in smaller total revenue.

Short Questions

9(a)(i) The law of demand states that within a specified period, an increase (a decrease) in price
will result in a decrease (an increase) in quantity demanded, ceteris paribus.

9(a)(ii) David does not behave according to the law of demand.

9(a)(iii) David has the lowest elasticity of demand. His elasticity of demand is zero (i.e. his demand
is perfectly inelastic). This is because his quantity demanded remains unchanged even if
there is an increase in price.

9(a)(iv) John has the highest elasticity of demand. His quantity demanded drops to zero after the
price is increased.

His quantity demanded drops by 100%. Since we are not told of the percentage increase in
price, we cannot find his elasticity of demand.

9(b) Traffic tends to be more congested during rush hours. This means that the time cost of taking
minibus rides during rush hours is higher than that during non-rush hours.

Structured Essay Question

10(a) The equilibrium market price is $16 and the quantity transacted is 40,000 cans.

10(b)(i) The new equilibrium price is $20 and the new quantity transacted is 30,000 cans.

New Introductory Economics 3rd Edition 12 © Pearson Education Asia Limited 2003
Suggested Solutions
 5 Price elasticity of demand and supply

10(b)(ii) The increase in cost is shared between producers and consumers.

P ($)
S2

F
20 S1

E
16
14

D1
Q
30,000 40,000

The $6 increase in per-unit cost results in a $4 increase in price. This means that consumers
have to bear (2/3) of the increase in cost.

As the market price is increased by $4 only, the remaining $2 increase in cost is borne by
the producers, which means that they share (1/3) of the increase in cost.

10(b)(iii) The elasticity of demand is

- 10,000 ($16 + $20)/2
Ed = × = -1.29
+ $4 (30,000 + 40,000) / 2

10(b)(iv) Demand for tinned fruit is elastic because

1) There are close substitutes for tinned fruit.

2) The tinned fruit is already quite expensive; therefore consumers are very concerned
about a further increase in its price. As a result, the quantity demanded drops
proportionately more.

10(c)(i) The demand for tinned fruit will increase, leading to an increase in both the price and the
quantity transacted of tinned fruit.
P

S1
F
P2

E
P1

D2

D1
Q
Q1 Q2

New Introductory Economics 3rd Edition 13 © Pearson Education Asia Limited 2003
Suggested Solutions
 5 Price elasticity of demand and supply

10(c)(ii) The supply of tinned fruit will drop, leading to an increase in the price but a decrease in the
quantity transacted of tinned fruit.

P
S2

S1
F
P2

E
P1

D1

Q
Q2 Q1

New Introductory Economics 3rd Edition 14 © Pearson Education Asia Limited 2003
Suggested Solutions