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ECON151Exam2Explanations

# ECON151Exam2Explanations - ECON 151 Explanations for the...

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ECON 151: Explanations for the Fall 2006 Second Exam 1. If the price elasticity of demand coefficient has a value of 1.11 then demand is elastic. Remember: If E d > 1, demand is defined as elastic If E d = 1, demand is defined as unitary elastic If E d <1, demand is defined as inelastic If E d , =0, demand is defined as perfectly inelastic If E d = infinity, demand is defined as perfectly elastic 2. Demand is perfectly elastic when E d = infinity, in other words, when the demand curve is horizontal. An elastic demand means that even a small change in price would result in big changes in quantity demanded (consumers are very responsive). An infinitely elastic demand means that even a tiny change in price would result in a huge (infinite) change in quantity demanded. 3. Along the higher, left-hand portion of a demand, prices are relatively high and the corresponding quantities are small. As the price starts to drop, the product becomes more attractive to us, we buy a higher quantity, and the first units that we buy are the most valuable to us. At the high prices portion of the demand, consumers tend to be relatively responsive to price changes (E d > 1). At low prices, we already consume big quantities, and do not value an addition unit consumed as much. Hence, we will not be as responsive to price changes at the low prices portion of the demand (E d <1, or demand is relatively inelastic). 4. E d = %change in the number of subscribers (Q) %change in the price of service (P) % change Q= 245,000- 255,000 * 100% = -0.04 * 100 % = 4% 250,000 % change P= 31.20- 28.80 * 100% = 0.08 * 100 % = 8% 30.00 E d = - 0.04/0.08 = 0.5 (inelastic) Note: that: because price and quantity demanded are inversely related, the price elasticity coefficient is always negative. But it is a convention in economics to take the absolute value (ignore the sign) of the coefficient. 5. Note that Total Expenditure = Price * Quantity The demand being relatively inelastic means that consumers do not decrease the quantity consumed by much as the price increases. As a result, their total expenditure increases. Remember:

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Price and quantity demanded are inversely related. This implies that as price increases, total expenditure will increase due to price increase and decrease due to quantity decrease. The net effect on total expenditure depends on the relative impact of the increase in price to that of the decrease in quantity. This can be determined from the elasticity of demand. If demand is elastic, it means the % change in quantity is greater than the % change in price. That implies when demand is elastic, the impact of the quantity change on total expenditure is greater than the impact of price change. Hence total expenditure declines when price increases. By the same reasoning we have the following relationship:
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ECON151Exam2Explanations - ECON 151 Explanations for the...

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