Gillespie: Foundations of Economics 4e © Andrew Gillespie, 2016. All rights reserved. Put into practice and end of chapter review questions Chapter 4 Review questions 1. Explain what it means if the price elasticity of demand is negative. It means the quantity demanded falls when price increases or vice versa. 2. Explain what it means if the price elasticity of demand equals zero. It means a change in price has no effect on the quantity demanded. Demand is perfectly inelastic 3. Explain how a firm can try to make demand for its products more price inelastic. Through branding; by developing a Unique Selling Point; by taking out a patent. 4. Is it better for a firm wanting to increase prices to have a price elastic or a price inelastic demand? If demand is price inelastic then a price increase increases total revenue. 5. If a firm has a high income elasticity of demand for its products how might this affect its marketing? A firm may target regions with fast growing incomes as this will lead to an ever greater proportionate change in the quantity demanded. 6. Explain what it means if the income elasticity of demand for a product is negative. It means an increase in income reduces the quantity demanded. The product is an inferior good. 7. Explain what it means if the value of the cross-price elasticity of demand is +2. It means an increase in the price of one product leads to an increase in the quantity demanded of another. The increase in quantity demanded is twice the increase in price (in percentages).Gillespie: Foundations of Economics 4e © Andrew Gillespie, 2016. All rights reserved. 8. How might an understanding of the cross-price elasticity of demand be useful to business? It can identify which products are complements and substitutes. It can anticipate a potential fall in demand if a substitute’s price is cut and take action to reduce the effect of this. 9. Explain why the statement ‘all other factors except price remain constant’ is important when calculating the price elasticity of demand. Because it measures the effect on quantity demanded of a change in price alone. If other factors change the impact on quantity demanded could be very different. 10. Explain how the price elasticity of demand varies along a demand curve. At high prices demand is price elastic. In the middle of the demand curve demand has unitary price elasticity. When price is low demand is price inelastic. Put into practice questions 1. The price elasticity of demand is −0.8. Price was £10. The price rises by 5 per cent. Sales were 2,000 units. What was the old revenue and what is the new revenue? Old revenue: £10 * 2000= £20000. New revenue: £10.50 * 2160 = £22680. 2. The income elasticity of demand is + 1.5. Sales have increased from 4,000 units to 4,500 units following a change in income. Originally the average income was £30,000. What did it change to? Increase in quantity demanded = 12.5% Income increase = 8.33% Income increased to £32,500 3. The cross-price elasticity of demand for product A with regards to changes in the price B is + 25. Calculate the effect on the quantity demanded of A if the price of B falls by 2 per cent. Quantity demanded falls by 50% .Gillespie: Foundations of Economics 4e © Andrew Gillespie, 2016. All rights reserved. 4. The quantity demanded of a product falls from 5,000 units to 4,000 units when the price rises from £30 to £32. Calculate the price elasticity of demand. Change in quantity demanded= -20% Change in price = + 6.66% Price elasticity of demand = -3 5. The price of product B increases from £50 to £55. The quantity demanded is A falls from 6,000 to 4,000 units. What is the cross-price elasticity of demand for A relative to B? Quantity demanded change = -33.33% Price change = +10% Cross price elasticity = -33.33/+10 = -3.33 6. If demand for a product is unit elastic then for a given percentage increase in price total revenue will: a. fall by the same percentage. b. increase by the same percentage. c. remain unchanged. d. fall by a smaller percentage. Explain your answer. Answer c. The percentage change in quantity demanded equals the percentage change in price. 7. An increase in income by 20 per cent will: a. increase demand for Z. b. decrease demand for X by 4 per cent. c. decrease demand for Y by 50 per cent. d. increase demand for X by 4 per cent. Explain your answer. Answer d: Increase demand for X by 4%. The income elasticity of demand is positive so an increase in income increases the quantity demanded. The value is 0.2 so an increase of 20% in income increases quantity demanded by 0.2*20=4%. 8. Which of the diagrams below shows: a. an inferior good? b. a good with an income elasticity of 0? c. a good with an income elasticity of infinity? d. a good with an income elasticity of more than 1?Gillespie: Foundations of Economics 4e © Andrew Gillespie, 2016. All rights reserved. Explain your answers. a = D b = C c = B d = A 9. A product, X, is an inferior good with no close substitutes. It is a complement to Y. Which best describes X? Explain your answer. Answer C. If it is an inferior good then the income elasticity of demand is negative. If X and Y are substitutes then the cross price elasticity of demand is positive; as the price of one product goes up people switch to the other