ECON 1001 AB Introduction to Economics I Dr. Ka-fu WONG

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ECON 1001 ABIntroduction to Economics IDr.
Ka-fu WONG

• Fourth week of tutorial sessions
• KKL 925, K812, KKL 106
• Clifford CHAN
• KKL 1109
• givencana_at_yahoo.ca

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Covered and to be covered

• Covered last week
• Dr. Wong finished up to kf004.ppt
• You should have at least read up to Chapter 4
  Elasticity.
• If not, please press hard on them. We are getting
  to the first midterm!
• Start reading Chapter 5 Demand The Benefit Side
  of the Market
• Your first midterm covering chapter 1 chapter 4
  will be held on this Saturday October 6, 2007 at
  9am
• To be covered in the tutorial sessions this week
• Problems in chapter 4 1, 3, 5, 7 and 9
• You are advised to work on the even ones as well

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Problem 1, Chapter 4

• On the accompanying demand curve, calculate the
  price elasticity of demand at points A, B, C, D
  and E.

Price
A
100
B
75
C
50
D
25
E
0
100
25
50
75
Quantity
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Solution to Problem 1 (1)

• Price elasticity of demand refers to the
  percentage change of quantity demanded relative
  to the percentage change of price
• In other words, price elasticity of demand
  indicates how much will the quantity demanded
  change with respect to a 1 change in price
• Thus, it measures the responsiveness of quantity
  demanded to change in price

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Solution to Problem 1 (2)

• Price elasticity of demand is always a negative
  index, as the demand curve is downward sloping
• For convenience, we always take absolute value of
  a price elasticity of demand
• When the absolute value of a price elasticity of
  demand is greater than one, that means percentage
  change in quantity demanded is greater than
  percentage change in price
• If this is the case, we regard the highly
  responsive demand as ELASTIC

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Solution to Problem 1 (3)

• When the absolute value of a price elasticity of
  demand is less than one, that means percentage
  change in quantity demanded is less than
  percentage change in price
• If this is the case, we regard the weakly
  responsive demand as INELASTIC
• When the absolute value of a price elasticity of
  demand is exactly equal to one, that means
  percentage change in quantity demanded is the
  same as percentage change in price
• If this is the case, we regard the
  mirror-responsive demand as UNITARY ELASTIC

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Solution to Problem 1 (4)

• General formula for (Own) Price Elasticity of
  Demand
• (Change of quantity demanded / Total quantity
  demanded) / (Change of price / Original Price)
• Rearranging terms, we will get
• (Change in quantity demanded / Change in price)
  (Original Price / Total quantity
  demanded)
• (1 / Slope of the demand curve) (P / Q)
• Using the formula, we can derive price elasticity
  of demand at any point along the demand curve

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Solution to Problem 1 (5)

• Point A
• 1 / Slope of the demand curve 1 / (-100/100) -1
• Price is 100 and quantity demanded is 0
• Price elasticity of demand -1 (100 / 0)
• Price elasticity of demand Infinity
• The demand is perfectly elastic
• Point B
• 1 / Slope of the demand curve -1
• Price is 75 and quantity demanded is 25
• Price elasticity of demand -1 (75 / 25)
• Price elasticity of demand -3 (Or 3 in if we
  take absolute value)
• As it is greater than 1, the demand is elastic

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Solution to Problem 1 (6)

• Point C
• 1 / Slope of the demand curve -1
• Price is 50 and quantity demanded is 50
• Price elasticity of demand -1 (50 / 50)
• Price elasticity of demand -1 (Or 1 if we take
  the absolute value)
• As it is exactly equal to 1, the demand is
  unitary elastic
• Point D
• 1 / Slope of the demand curve -1
• Price is 25 and quantity demanded is 75
• Price elasticity of demand -1 (25 / 75)
• Price elasticity of demand -1/3 (Or 1/3 if we
  take the absolute value)
• As it is less than 1, the demand is inelastic

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Solution to Problem 1 (7)

• Point E
• 1 / Slope of the demand curve -1
• Price is 0 and quantity demanded is 100
• Price elasticity of demand -1 (0 / 100)
• Price elasticity of demand 0 (Or 0 if we take
  the absolute value)
• As it is exactly equal to 0, the price elasticity
  of demand is zero
• The demand is perfectly inelastic- the quantity
  demanded does not change regardless of the change
  in price

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Problem 3, Chapter 4

• Suppose, while rummaging through your uncles
  closet, you found the original painting of Dogs
  Playing Poker, a valuable piece of art. You
  decided to set up a display in your uncles
  garage. The demand curve to see this valuable
  piece of art is as shown in the diagram. What
  price should you charge if your goal is to
  maximize your revenues from tickets sold? On a
  graph, show the inelastic and elastic regions of
  the demand curve.

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Price (/visit)
0
6
Quantity (visitors/day)
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Solution to Problem 3 (1)

• Where is the source of revenue from displaying
  the artwork in your uncles garage?
• Selling admission tickets to your uncles garage
• How much should you charge in order to maximize
  the revenue?
• You should charge a price where the marginal
  revenue marginal cost
• However, no supply curve is given in this
  problem, and we can only consider the demand
  curve alone
• How much should you charge then?
• You should charge at the price where it is the
  midpoint of the demand curve

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Solution to Problem 3 (2)

• At the midpoint of a linear demand curve, the
  price elasticity of demand is unitary elastic (1)
• Percentage of change in quantity demanded
  Percentage of change in price
• Left of the midpoint, the price elasticity of
  demand is elastic (gt1)
• Percentage of change in quantity demanded is
  greater than Percentage of change in price
• Lowing the price will lead to an increase in
  quantity demanded, and thus revenue will go up

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Solution to Problem 3 (3)

• Right of the midpoint, the price elasticity of
  demand is inelastic (lt1)
• Percentage of change in quantity demanded is less
  than Percentage of change in price
• Increasing the price will only lead to a slight
  decrease in quantity demanded, and thus revenue
  will go up
• At the midpoint,
• Further change in price will cause total revenue
  fall
• The optimal price is settled at the midpoint of a
  demand curve
• Therefore, you should charge 6 for each
  admission ticket where the total quantity
  demanded is 3

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Solution to Problem 3 (4)
Price ( per visit)
12
Elastic region
Midpoint
6
Inelastic region
Quantity (Visitors per day)
6
3

• Elastic region is located on the left of the
  midpoint
• Inelastic region is located on the right of the
  midpoint

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Problem 5, Chapter 4

• Among the following groups- senior executives,
  junior executives, and students- which is likely
  to have the most and which is likely to have the
  least price-elastic demand for membership in the
  Association of Business Professionals?

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Solution to Problem 5 (1)

• Senior executives are most likely to have a least
  price-elastic demand for membership in the
  Association of Business Professionals
• Senior executives have a higher income than
  junior executives, while junior executives have a
  higher income than students
• The membership shares only a small portion of the
  income earned by a typical senior executive
• Change in price of the membership causes a small
  effect on senior executive

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Solution to Problem 5 (2)

• The membership shares a notable portion of the
  income earned by a typical junior executive
• Change in price of the membership causes a
  notable effect on junior executives
• The membership shares a considerable portion of
  the income earned by a typical student
• Change in price of the membership causes a
  considerable effect on students
• In general, one earning high income is less
  likely to respond to change in price dramatically
  as the price is actually a very small portion of
  ones consumption budget

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Solution to Problem 5 (3)

• Therefore, senior executives have a least
  price-elastic demand for the membership
• Which of the three groups has the most
  price-elastic demand for the membership?
• Students
• They earning the lowest income among the groups
  will be affected the most by the change in price
  of the membership as it takes a considerable
  portion of their income
• Hence, they will probably respond dramatically to
  change in the price of the membership

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Problem 7, Chapter 4

• What are the respective price elasticities of
  supply at A and B on the supply curve shown in
  the accompanying figure?

S
B
6
Change in price
A
Price
4
Change in quantity
0
9
12
Quantity
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Solution to Problem 7 (1)

• Calculating price elasticity of supply is almost
  identical to calculating price elasticity of
  demand, except for the slope of the curve
• Price elasticity of supply refers to the
  percentage change of quantity supplied relative
  to the percentage change of price
• In other words, price elasticity of supply
  indicates how much will the quantity supplied
  change with respect to a 1 change in price
• Thus, it measures the responsiveness of quantity
  supplied to change in price

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Solution to Problem 7 (2)

• Price elasticity of supply is always a positive
  index, as the supply curve is upward sloping
• When a price elasticity of supply is greater than
  one, that means percentage change in quantity
  supplied is greater than percentage change in
  price
• If this is the case, we regard the highly
  responsive supply as ELASTIC

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Solution to Problem 7 (3)

• When a price elasticity of supply is less than
  one, that means percentage change in quantity
  supplied is less than percentage change in price
• If this is the case, we regard the weakly
  responsive supply as INELASTIC
• When a price elasticity of supply is exactly
  equal to one, that means percentage change in
  quantity supplied is the same as percentage
  change in price
• If this is the case, we regard the
  mirror-responsive supply as UNITARY ELASTIC

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Solution to Problem 7 (4)

• General formula for (Own) Price Elasticity of
  Supply
• (Change of quantity supplied / Total quantity
  supplied) / (Change of price / Original Price)
• Rearranging terms, we will get
• (Change in quantity supplied / Change in price)
  (Original Price / Total quantity
  supplied)
• (1/ Slope of the supply curve) (P / Q)
• Using the formula, we can derive price elasticity
  of supply at any point along the supply curve

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Solution to Problem 7 (5)

• Point A
• 1 / Slope of the supply curve 1 / (2/3) 3/2
• Price is 4 and quantity supplied is 9
• Price elasticity of supply 3/2 (4 / 9)
• Price elasticity of supply 2/3
• As it is less than 1, the supply is inelastic
• Point B
• 1 / Slope of the supply curve 1 / (2/3) 3/2
• Price is 6 and quantity supplied is 12
• Price elasticity of supply 3/2 (6 / 12)
• Price elasticity of supply 3/4
• As it is less than 1, the supply is inelastic

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Problem 9, Chapter 4

• At point A on the demand curve shown, by what
  percentage will a 1 percent increase in the price
  of the product affect the total expenditure on
  the product?

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Price (/unit)
A
4
18
6
Quantity (units/week)
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Solution to Problem 9 (1)

• In order to answer this question, we will need to
  compute the price elasticity of demand
• Applying the general formula, Price elasticity of
  demand (1/ Slope of the demand curve) (P/Q),
  we get
• Price elasticity of demand
• 1 / Slope of the demand curve 1 / (-1/3) -3
• Price is 4 and the quantity demanded is 6
• Price elasticity of demand -3 (4/6) -2 (Or
  2 if we take the absolute value)
• As it is greater than 1, the demand is elastic

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Solution to Problem 9 (2)

• Based on the price elasticity of demand, we
  conclude that a 1-percent increase in price will
  cause a 2-percent decrease in quantity demanded
  for the product
• How much does the total expenditure change?
• Total expenditure (TE) Price (P) Quantity (Q)
• What will happen if the price increases by 1 and
  quantity demanded decreases by 2?
• Initially, TE P Q
• After the change in price, TE will become 1.01P
  0.98Q

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Solution to Problem 9 (3)

• From the Total Expenditure function 1.01P
  0.98Q, a 0.02 decrease in quantity demanded with
  a 0.01 increase in price of the product, will
  approximately lead to a 0.01 (1) reduction in
  Total Expenditure.

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The end

• Thanks for coming!
• Good luck in your midterm!!!