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 €2.50, weekly sales change from 400 to 460. Use the midpoint (arc) method to find the price elasticity of demand E.
P1 = €4.00P2 = €2.50Q1 = 400Q2 = 460
E =
2.Price elasticity of demandHard
Demand for a product has a constant price elasticity of −2, so Q = A·P^−2. At a price of €20, 10 000 units are sold. How many units Q are sold at a price of €14.00?
E = −2P1 = €20Q1 = 10 000P2 = €14.00
Q = units
3.Economics conceptsMedium
Rising consumer confidence would most likely:
- AShift aggregate demand to the right
- BShift aggregate supply to the left
- CShift aggregate demand to the left
- DHave no effect on the economy
4.Economics conceptsHard
The time-inconsistency problem in monetary policy (Kydland and Prescott) is a key argument for:
- AGovernments setting interest rates directly, especially before elections
- BFixing the money supply at zero growth
- CIndependent central banks with a credible commitment to low inflation
- DAbolishing central banks entirely
3Solutions
1.Price elasticity of demand
Answer: E = −0.3023
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
(460 − 400)/((400 + 460)/2) = 60/430 = 0.1395
Relative change in price
(2.5 − 4)/((4 + 2.5)/2) = −1.5/3.25 = −0.4615
Elasticity
E = 0.1395/−0.4615 = −0.3023
Answer
E = −0.3023
2.Price elasticity of demand
Answer: Q = 20408 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 = 14/20 = 0.7
New quantity
Q = 10 000·0.7−2 = 10 000·2.041 = 20408
Answer
Q = 20408
3.Economics concepts
Answer: A · 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
A · Shift aggregate demand to the right
4.Economics concepts
Answer: C · Independent central banks with a credible commitment to low inflation
Why this is the answer
If the public expects policymakers to inflate later, expectations and inflation rise; delegating policy to an independent, credible central bank reduces this bias.
Answer
C · Independent central banks with a credible commitment to low inflation
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