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 €5.00, weekly sales change from 800 to 640. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €4.00P2 = €5.00Q1 = 800Q2 = 640
E =
2.Price elasticity of demandHard
The (inverse) demand for a product is P = 80 − 0.5Q, with P in euros. Find the price elasticity of demand E when 48 units are sold.
P = 80 − 0.5QQ = 48
E =
3.Economics conceptsMedium
Unemployment benefits and progressive income taxes are called automatic stabilisers because they:
- AKeep the government budget balanced in every year of the business cycle
- BFix the exchange rate automatically
- CPrevent all recessions from happening
- DReduce fluctuations in demand without new government decisions
4.Economics conceptsHard
Purchasing power parity (PPP) suggests that, in the long run, exchange rates adjust so that:
- ATrade balances are always zero
- BThe same basket of goods costs the same in different countries
- CEvery currency ends up having the same nominal value as the US dollar
- DInterest rates are equal in all countries
3Solutions
1.Price elasticity of demand
Answer: E = −1
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
(640 − 800)/((800 + 640)/2) = −160/720 = −0.2222
Relative change in price
(5 − 4)/((4 + 5)/2) = 1/4.5 = 0.2222
Elasticity
E = −0.2222/0.2222 = −1
Answer
E = −1
2.Price elasticity of demand
Answer: E = −2.333
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.
Price at this quantity
P = 80 − 0.5·48 = €56.00
Point elasticity
dQ/dP = −1/0.5 = −2
E = −2·56/48 = −2.333
Answer
E = −2.333
|E| > 1: demand is elastic.
3.Economics concepts
Answer: D · Reduce fluctuations in demand without new government decisions
Why this is the answer
In a downturn tax revenue falls and benefit payments rise automatically, supporting incomes and spending; the reverse happens in a boom.
Answer
D · Reduce fluctuations in demand without new government decisions
4.Economics concepts
Answer: B · The same basket of goods costs the same in different countries
Why this is the answer
PPP is based on the law of one price: if a good is cheaper in one country, arbitrage should push exchange rates towards equalising prices, though transport costs and non-traded goods limit this.
Answer
B · The same basket of goods costs the same in different countries
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