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 €20.00 to €16.00, weekly sales change from 1000 to 1160. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €20.00P2 = €16.00Q1 = 1000Q2 = 1160
E =
2.Price elasticity of demandHard
The demand for a product is Q = 800 − 20P, with P in euros. Find the price elasticity of demand E at a price of €8.
Q = 800 − 20PP = €8
E =
3.Economics conceptsMedium
Rising consumer confidence would most likely:
- AShift aggregate demand to the left
- BShift aggregate demand to the right
- CShift aggregate supply to the left
- DHave no effect on the economy
4.Economics conceptsHard
Akerlof's "market for lemons" explains how:
- APublic goods are under-provided
- BMonopolies set high prices
- CLemons become cheaper in summer
- DAsymmetric information can drive good-quality products out of a market
3Solutions
1.Price elasticity of demand
Answer: E = −0.6667
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
(1160 − 1000)/((1000 + 1160)/2) = 160/1080 = 0.1481
Relative change in price
(16 − 20)/((20 + 16)/2) = −4/18 = −0.2222
Elasticity
E = 0.1481/−0.2222 = −0.6667
Answer
E = −0.6667
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 = 800 − 20·8 = 640
Point elasticity
dQ/dP = −20
E = (dQ/dP)·P/Q = −20·8/640 = −0.25
Answer
E = −0.25
|E| < 1: demand is inelastic.
3.Economics concepts
Answer: B · Shift aggregate demand to the right
Why this is the answer
Higher confidence raises consumption at every price level, shifting AD right and raising output and, possibly, prices in the short run.
Answer
B · Shift aggregate demand to the right
4.Economics concepts
Answer: D · Asymmetric information can drive good-quality products out of a market
Why this is the answer
When buyers cannot judge quality they pay an average price; owners of good cars withdraw, average quality falls, and the market may collapse.
Answer
D · Asymmetric information can drive good-quality products out of a market
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