Price elasticity of demand
- Price elasticity (midpoint)
- E = (ΔQ/Q̄)/(ΔP/P̄)
- Elastic / inelastic
- |E| > 1 elastic, |E| < 1 inelastic
- Revenue
- TR = P·Q
Microeconomics: cram pack
Formula sheets, the key method steps for every topic and 4 practice problems, with full solutions at the back.
1Formulas and methods
2Practice problems
1.Price elasticity of demandMedium
When the price of a ticket changes from €2.00 to €0.50, weekly sales change from 400 to 760. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €2.00P2 = €0.50Q1 = 400Q2 = 760
E =
2.Price elasticity of demandHard
The demand for a product is Q = 160 − 2P, with P in euros. Find the price elasticity of demand E at a price of €16.
Q = 160 − 2PP = €16
E =
3.Economics conceptsMedium
The law of diminishing marginal returns states that:
- AConsumers get less satisfaction as prices rise
- BAdding more of a variable input to a fixed input eventually lowers the extra output per unit added
- CTotal output always falls as more workers are hired
- DLong-run average costs always fall as output rises
4.Economics conceptsHard
Okun's law describes:
- AThe link between money supply and prices
- BA positive relationship between inflation and nominal interest rates over time
- CThe relationship between tax rates and revenue
- DA negative relationship between output growth and changes in unemployment
3Solutions
1.Price elasticity of demand
Answer: E = −0.5172
Price elasticity of demand measures how strongly the quantity demanded reacts to price: E = (% change in quantity)/(% change in price). It is negative for normal goods. |E| > 1 is elastic (revenue falls when price rises), |E| < 1 is inelastic.
Relative change in quantity
(760 − 400)/((400 + 760)/2) = 360/580 = 0.6207
Relative change in price
(0.5 − 2)/((2 + 0.5)/2) = −1.5/1.25 = −1.2
Elasticity
E = 0.6207/−1.2 = −0.5172
Answer
E = −0.5172
2.Price elasticity of demand
Answer: E = −0.25
Price elasticity of demand measures how strongly the quantity demanded reacts to price: E = (% change in quantity)/(% change in price). It is negative for normal goods. |E| > 1 is elastic (revenue falls when price rises), |E| < 1 is inelastic.
Quantity at this price
Q = 160 − 2·16 = 128
Point elasticity
dQ/dP = −2
E = (dQ/dP)·P/Q = −2·16/128 = −0.25
Answer
E = −0.25
|E| < 1: demand is inelastic.
3.Economics concepts
Answer: B · Adding more of a variable input to a fixed input eventually lowers the extra output per unit added
Why this is the answer
In the short run, with at least one fixed factor, marginal product eventually falls, which makes marginal cost rise.
Answer
B · Adding more of a variable input to a fixed input eventually lowers the extra output per unit added
4.Economics concepts
Answer: D · A negative relationship between output growth and changes in unemployment
Why this is the answer
Okun observed that unemployment falls when real GDP grows faster than its trend rate and rises when growth is below trend.
Answer
D · A negative relationship between output growth and changes in unemployment
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