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 €40.00 to €34.00, weekly sales change from 1200 to 1340. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €40.00P2 = €34.00Q1 = 1200Q2 = 1340
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 €4, 2 000 units are sold. How many units Q are sold at a price of €2.80?
E = −0.5P1 = €4Q1 = 2 000P2 = €2.80
Q = units
3.Economics conceptsMedium
The principle of diminishing marginal utility states that:
- AConsumers always prefer more expensive goods
- BSatisfaction rises as income falls
- CTotal satisfaction falls with each additional unit of the good that is consumed
- DExtra satisfaction from each additional unit consumed tends to fall
4.Economics conceptsHard
A liquidity trap is a situation where:
- ABanks have no money left to lend
- BThe central bank raises interest rates sharply to fight high and rapidly rising inflation
- CInflation is very high and rising
- DInterest rates are near zero and further monetary expansion has little effect on demand
3Solutions
1.Price elasticity of demand
Answer: E = −0.6798
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
(1340 − 1200)/((1200 + 1340)/2) = 140/1270 = 0.1102
Relative change in price
(34 − 40)/((40 + 34)/2) = −6/37 = −0.1622
Elasticity
E = 0.1102/−0.1622 = −0.6798
Answer
E = −0.6798
2.Price elasticity of demand
Answer: Q = 2390 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 = 2.8/4 = 0.7
New quantity
Q = 2 000·0.7−0.5 = 2 000·1.195 = 2390
Answer
Q = 2390
3.Economics concepts
Answer: D · Extra satisfaction from each additional unit consumed tends to fall
Why this is the answer
As consumption of a good increases, the marginal utility of each extra unit usually declines, which helps explain downward-sloping demand.
Answer
D · Extra satisfaction from each additional unit consumed tends to fall
4.Economics concepts
Answer: D · Interest rates are near zero and further monetary expansion has little effect on demand
Why this is the answer
When nominal rates are near their lower bound, people hold extra money rather than spend it, so conventional monetary policy loses power and fiscal policy or unconventional tools matter more.
Answer
D · Interest rates are near zero and further monetary expansion has little effect on demand
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