Capitulo 4 Microecomonia Parkin

An s w e r s t o t h e R e v i e w Q u i z z e s

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1. Why do we need a units-free measure of the responsiveness of the quantity demanded of a

good or service to a change in its price?

The elasticity of demand is a units-free measure. Compare it as a measure of the responsiveness to some

other candidate that depends on the units, such as the slope. The slope of the demand curve changes as the

units measuring the same quantity of the good change (going from pounds to ounces, for example). The

value of the elasticity is independent of the units used to measure the price and quantity of the product. As

a result, the elasticity can be compared across the same good when quantity is measured in different units

and/or the price is measured in different currencies. The elasticities of different goods also can be compared

even though they are measured in different units.

2. Define price elasticity of demand and show how it is calculated.

The price elasticity of demand is units-free measure of the responsiveness of the quantity demanded of a

good to a change in its price when all other influences on buying plans remain the same. It equals the

absolute value (or magnitude) of the ratio of the percentage change in the quantity demanded to the

percentage change in the price. The percentage change in quantity (price) is measured as the change in

quantity (price) divided by the average quantity (price).

3. Why, when we calculate the price elasticity of demand, do we express the change in price as a

percentage of the average price and the change in quantity as a percentage of the average

quantity?

Using the average of both price and quantity gives the elasticity at the midpoint between the original price

and the new price. If we only used percentage change from the original price, we would have a larger value

for the elasticity between two prices when calculating the elasticity for a price fall than when calculating it

for a price rise. Using the average price and quantity measures avoids the value of elasticity being

dependent upon whether a price change reflects a price increase or decrease.

4. What is the total revenue test? Explain how it works.

The total revenue test is a method of estimating the price elasticity of demand by observing the change in

total revenue, given a change in price, holding all other things constant. The total revenue test shows that a

price cut increases total revenue if demand is elastic, decreases total revenue if demand is inelastic, and does

not change total revenue if demand is unit elastic.

5. What are the main influences on the elasticity of demand that make the demand for some

goods elastic and the demand for other goods inelastic?

The magnitude of the price elasticity of demand for a good depends on three main influences:

• Closeness of substitutes. The more easily people can substitute other items for a particular good, the

larger is the price elasticity of demand for that good.

C h a p t e r 4 ELASTICITY

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5 8 CHAP T E R 4

• The proportion of income spent on the good. The larger the portion of the consumer’s budget being

spent on a good, the greater is the price elasticity of demand for that good.

• The time elapsed since a price change. Usually, the more time that has passed after a price change, the

greater is the price elasticity of demand for a good.

6. Why is the demand for a luxury generally more elastic than the demand for a necessity?

Demand for a necessity is generally less elastic than demand for a luxury because there are fewer substitutes

for a necessity.

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1. What does the cross elasticity of demand measure?

The cross elasticity of demand measures how the quantity demanded of one good responds to a change in

the price of another good. The formula for the cross elasticity of demand is the percentage change in the

quantity of the good demanded divided by the percentage change in the price of the related good.

2. What does the sign (positive versus negative) of the cross elasticity of demand tell us about the

relationship between two goods?

The sign of the cross elasticity of demand reveals whether two goods are substitutes or compliments: The

cross elasticity of demand is positive for substitutes and negative for complements.

3. What does the income elasticity of demand measure?

The income elasticity of demand measures how the quantity demanded of a good responds to a change in

income. The formula for the income elasticity of demand is the percentage change in the quantity of the

good demanded divided by the percentage change in income.

4. What does the sign (positive versus negative) of the income elasticity of demand tell us about a

good?

The sign of the income elasticity

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