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 €4.00 to €2.50, weekly sales change from 400 to 460. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €4.00P2 = €2.50Q1 = 400Q2 = 460
E =
2.Price elasticity of demandHard
Demand for a product has a constant price elasticity of −0.5, so Q = A·P^−0.5. At a price of €8, 5 000 units are sold. How many units Q are sold at a price of €4.00?
E = −0.5P1 = €8Q1 = 5 000P2 = €4.00
Q = units
3.Economics conceptsMedium
The marginal propensity to consume is:
- AThe share of an extra euro of income that is spent on consumption
- BThe total consumption in an economy
- CThe interest rate on consumer loans
- DThe average share of total income that households save over a year
4.Economics conceptsHard
Which is a key difference between the CPI and the GDP deflator?
- AThey always give exactly the same inflation rate
- BThe GDP deflator includes imported goods; the CPI does not
- CThe CPI includes prices of imported consumer goods; the GDP deflator covers only domestically produced goods
- DThe CPI covers investment goods; the GDP deflator does not
3Solutions
1.Price elasticity of demand
Answer: E = −0.3023
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
(460 − 400)/((400 + 460)/2) = 60/430 = 0.1395
Relative change in price
(2.5 − 4)/((4 + 2.5)/2) = −1.5/3.25 = −0.4615
Elasticity
E = 0.1395/−0.4615 = −0.3023
Answer
E = −0.3023
2.Price elasticity of demand
Answer: Q = 7071 units
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.
Ratio of the prices
P2/P1 = 4/8 = 0.5
New quantity
Q = 5 000·0.5−0.5 = 5 000·1.414 = 7071
Answer
Q = 7071
3.Economics concepts
Answer: A · The share of an extra euro of income that is spent on consumption
Why this is the answer
The MPC measures how consumption changes with income; it determines the size of the Keynesian multiplier, 1/(1 − MPC).
Answer
A · The share of an extra euro of income that is spent on consumption
4.Economics concepts
Answer: C · The CPI includes prices of imported consumer goods; the GDP deflator covers only domestically produced goods
Why this is the answer
The CPI uses a fixed basket of consumer goods, including imports, while the deflator covers all domestically produced output with changing weights.
Answer
C · The CPI includes prices of imported consumer goods; the GDP deflator covers only domestically produced goods
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