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 €12.00 to €14.00, weekly sales change from 400 to 270. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €12.00P2 = €14.00Q1 = 400Q2 = 270
E =
2.Price elasticity of demandHard
Demand for a product has a constant price elasticity of −1.2, so Q = A·P^−1.2. At a price of €5, 8 000 units are sold. How many units Q are sold at a price of €4.50?
E = −1.2P1 = €5Q1 = 8 000P2 = €4.50
Q = units
3.Economics conceptsMedium
Comparative advantage means a country should specialise in goods it can produce:
- AMore cheaply in absolute terms than every other country
- BOnly for its own consumption
- CWith the most workers
- DAt a lower opportunity cost than other countries
4.Economics conceptsHard
The Fisher effect predicts that, in the long run, a permanent 2 percentage point rise in expected inflation will:
- ARaise nominal interest rates by about 2 points, leaving real rates unchanged
- BHave no effect on nominal interest rates, so real interest rates fall by about 2 points
- CRaise real interest rates by about 2 points
- DLower nominal interest rates by about 2 points
3Solutions
1.Price elasticity of demand
Answer: E = −2.522
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
(270 − 400)/((400 + 270)/2) = −130/335 = −0.3881
Relative change in price
(14 − 12)/((12 + 14)/2) = 2/13 = 0.1538
Elasticity
E = −0.3881/0.1538 = −2.522
Answer
E = −2.522
2.Price elasticity of demand
Answer: Q = 9078 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 = 4.5/5 = 0.9
New quantity
Q = 8 000·0.9−1.2 = 8 000·1.135 = 9078
Answer
Q = 9078
3.Economics concepts
Answer: D · At a lower opportunity cost than other countries
Why this is the answer
Even a country that is less efficient at everything gains from trade by specialising where its opportunity cost is lowest.
Answer
D · At a lower opportunity cost than other countries
4.Economics concepts
Answer: A · Raise nominal interest rates by about 2 points, leaving real rates unchanged
Why this is the answer
Lenders demand compensation for expected inflation, so nominal rates move one-for-one with it in the long run while the real rate is set by real factors.
Answer
A · Raise nominal interest rates by about 2 points, leaving real rates unchanged
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