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 €3.00, weekly sales change from 200 to 120. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €2.00P2 = €3.00Q1 = 200Q2 = 120
E =
2.Price elasticity of demandHard
The demand for a product is Q = 240 − 4P, with P in euros. Find the price elasticity of demand E at a price of €42.
Q = 240 − 4PP = €42
E =
3.Economics conceptsMedium
In perfect competition in the long run, firms earn:
- AMonopoly profits
- BLarge economic profits
- CZero economic profit
- DLosses forever
4.Economics conceptsHard
A Giffen good is one where:
- ADemand rises with income, like most goods
- BDemand rises because the good is a status symbol
- CThe price never changes
- DQuantity demanded rises when its price rises, because a strong income effect outweighs the substitution effect
3Solutions
1.Price elasticity of demand
Answer: E = −1.25
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.
Relative change in quantity
(120 − 200)/((200 + 120)/2) = −80/160 = −0.5
Relative change in price
(3 − 2)/((2 + 3)/2) = 1/2.5 = 0.4
Elasticity
E = −0.5/0.4 = −1.25
Answer
E = −1.25
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.
Quantity at this price
Q = 240 − 4·42 = 72
Point elasticity
dQ/dP = −4
E = (dQ/dP)·P/Q = −4·42/72 = −2.333
Answer
E = −2.333
|E| > 1: demand is elastic.
3.Economics concepts
Answer: C · Zero economic profit
Why this is the answer
Profits attract entry and losses cause exit until price equals minimum average cost and economic profit is zero.
Answer
C · Zero economic profit
4.Economics concepts
Answer: D · Quantity demanded rises when its price rises, because a strong income effect outweighs the substitution effect
Why this is the answer
For a Giffen good the income effect of a price rise (feeling poorer, buying more of the cheap staple) dominates the substitution effect, so demand slopes upward.
Answer
D · Quantity demanded rises when its price rises, because a strong income effect outweighs the substitution effect
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