Ch04-AK

1) To calculate percentage change, use %D = (New – Old)/Old. Since prices are declining, “old” prices will be the larger numbers. Here is the output:

Price = 1000 - Q
P	Q	%DP	%DQD	PED
800	200
600	400	-25.00%	100.00%	4
400	600	-33.33%	50.00%	1.5
200	800	-50.00%	33.33%	0.6667

A) PED=4

B) PED=2/3

C) Demand becomes less elastic as prices decline (and quantities rise) if we have a linear demand curve. Despite the constant slope of a linear demand curve, the PED will not be constant.

2A) No. A PED of 0.2 implies that a 1% rise in price leads to a 0.2% decline in quantity demanded.

Also, since %DTR = %DP * (1 – PED)

We know that a 1% rise in price leads to a 0.8% rise in revenue.

2B) No. The PED for cars will be much lower than that for Fords, since Fords have many substitutes and cars do not.

3) The key to illustrating this concept clearly is to draw two sets of axes with identical supply curves (shifting supply up by the size of the tax). On one diagram, draw inelastic demand (cigarettes). On the other, draw elastic demand (movie tickets). In both cases, the vertical shift will be the same. Note, however, that the change in quantity demanded is much greater for the elastic good. This means the efficiency loss (the DWL) is much bigger for the elastic good. The DWL is shaded below.

4) Firm A is facing physical constraints, so its supply will be inelastic. Firm B can respond to price changes by increasing production, so its supply is elastic.

5) Low income people consume MySpace, but high income people consume Facebook. As incomes rise, people consume less MySpace and more Facebook. This implies that MySpace is an inferior good, so its income elasticity is negative. Facebook is probably a luxury good. Since this is a type of normal good, we know the income elasticity for Facebook is greater than zero.