Answers to Study Exercises

Question 1

a) 2; relatively elastic

b) 0.4; relatively inelastic

c) 1; unit elastic

Question 3

a) The diagram below shows the relevant information and assumes that both demand and
supply curves are linear. Point E is the initial equilibrium.

b) An increase in price from $2.00 to $3.00 per can leads to a reduction in quantity demanded
from 4200 to 3000 cans per month. Thus the own-price elasticity of demand is:

 = (1200/3600)/(1.00/2.50) = (1/3)/(2/5) = 0.83

This is relatively inelastic demand.

c) An increase in price from $2.00 per can to $3.00 per can leads to an increase in quantity
supplied from 4200 to 4500 cans per month. Thus the own-price elasticity of supply is:

S = (300/4350)/(1.00/2.50) = (.0689)/(0.4) = 0.17

This is relatively inelastic supply.

e) The ability of producers to substitute toward the production of other goods is the key factor
affecting supply elasticity. Can their equipment be used for other purposes? Can their
management skills be easily shifted?

Question 4
a) The record harvests shifted the supply curve to the right and reduced prices. The “disastrous”
result for farmers suggests that their incomes have fallen. This would occur if demand for wheat
is inelastic.
b) We conclude that demand for bus travel is inelastic since total expenditure on bus travel
apparently declines as price declines.
c) Demand for cell phones is apparently elastic, since total expenditure on cell phones rises as
price declines (because quantity demanded increases by a larger proportion than the decline in
price).
d) The speaker is asserting that he or she has a perfectly inelastic demand for coffee. This is
possible over some, but not all, ranges of price––how about at a price of $1000 per cup? Also,
one person’s perfectly inelastic demand is not sufficient to make market demand perfectly
inelastic.
e) The demand for housing is increasing greatly in Vancouver. Therefore the demand curve is
shifting to the right. This causes the price to increase (as we move up along an upward-sloping,
and likely very inelastic, supply curve). As price rises, we also move (along) any given demand
curve. But this tells us nothing about the elasticity of demand.

Question 7

The demand for the stamps is downward sloping, as shown in the diagram below. The supply is a
vertical line at Q=2. If the stamp dealer sold both stamps, the equilibrium price would be p2 and
his total revenue would be the dark shaded area. If, instead, he chooses to burn one stamp, the
supply (after the fire) will be a vertical line at Q=1. If he now sells the single stamp, the
equilibrium price will be higher at p1 and his total revenue would be the light shaded area. It
should be clear from the diagram that if the demand curve is sufficiently inelastic then p1 will be
much higher than p2 and the total revenue from the single stamp when sold at p1 will exceed the
total revenue of the two stamps when each is sold at p2. In this case the decision to burn the
stamp would be wealth maximizing and perfectly sensible.
Question 8

a) The relevant concept is that of the own-price elasticity of demand, since we are considering
changes in the price and quantity of ticket sales. The measure of elasticity in this case is the
percentage change in quantity demanded divided by the percentage change in price. The average
quantity is 1275 and the average price is $12.50. Thus, we have:

 = (150/1275)/(3/12.50) = 0.49

b) The relevant concept is that of the income elasticity of demand because we are relating
changes in income to changes in quantity demanded. The measure of income elasticity is the
percentage change in quantity demanded divided by the percentage change in income. The
average quantity of BMWs sold is 61,500. Note that we are given the percentage change in
income equal to 10 percent or 0.10. Thus we have:

Y = (11,000/61,500)/(0.10) = 1.79

The positive sign reveals that BMWs are a normal good since a rise in income leads to an increase
in quantity demanded.

c) The relevant concept is that of the cross-price elasticity of demand because we are relating
changes in the price of coffee to changes in the quantity demanded of tea. The measure of cross-
price elasticity is the percentage change in the quantity demanded of tea divided by the
percentage change in the price of coffee. The average coffee price is $3.90 and the average
quantity of tea is 7 750 kg. Thus we have:

XY = (500/7,750)/(1.80/3.90) = 0.14

The positive sign reveals that coffee and tea are substitute goods since a rise in the price of coffee
(which presumably reduces the quantity demanded of coffee) leads people to demand more tea.
d) The relevant concept is the Canadian own-price elasticity of supply because we are relating
changes in the world price of pulp to changes in the quantity of pulp supplied by Canadian firms.
The measure of supply elasticity is the percentage change in (Canadian) quantity supplied divided
by the percentage change in the world price. The average quantity is 9.5 million tonnes. Note that
we are given the percentage increase in the price equal to 14 percent, or 0.14. Thus we have:

S = (3/9.5)/(0.14) = 2.26

The interpretation of this number is that a 10% increase in the world price of pulp leads to a
22.6% increase in the quantity of pulp supplied by Canadian producers.

e) The relevant concept is income elasticity. The percentage change in quantity (relative to the
average) is 66.7 percent (40/60) while the percentage change in income (relative to the average)
is 14 percent (9000/64500). So the income elasticity of Marta’s demand for fruits and vegetables
is 66.7/14 = 4.76. These are evidently luxury goods for Marta.

f) This is own-price elasticity of demand. The percentage change in price (fees) is 25 percent
(5000/20000) and the percentage change in the quantity is (negative) 40 percent (4000/10000).
So the elasticity of demand is 40/25 =1.6.