9/27/2014

Workshop 3
Markets in Action

1.(a) The price elasticity of demand

measures the responsiveness of
the quantity demanded / price to a
change in the quantity demanded / the
quantity supplied / price.

(b) Give the formula for price elasticity of

demand.
PεD = (ΔQ/ΔP)*(P/Q)
= (ΔQ/Q)/(ΔP/P)

2.In the mid 1990s, the government in the

UK announced that for every 10 per cent
rise in the price of cigarettes, the
demand is likely to fall by 6 per cent.

If this information is correct, what is the

value of the price elasticity of demand for
cigarettes?

PεD = -6%/10% = -0.6

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3. In each of the following pairs, tick which of the

two items is likely to have the more elastic demand.
Give reasons for your answer
Petrol (all brands) Esso petrol
Other brands of petrol are good substitutes

Holidays abroad Bread

Holidays in Britain are a substitute? Depends
on income level.

Salt Clothing
Salt represents a small part of the budget.

4. Using the demand curve from the

lecture (Q = 50 – 5P), calculate the
price elasticity of demand:

a) Between £8 and £9
b) Between £4 and £6
c) Between £2 and £4
d) Between £2 and £1
e) At a price of £5

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f) Using your answers to the

previous questions explain what
happens to the price elasticity of
demand as you move upwards
along a demand curve. Sketch
the demand curve to help
illustrate your answer.

P 10
DQ P
Ped = 
Elasticity
DP Q
-5.67 increases as
8
you move
-2.33
n
upwards along
6 the demand
P (£) -1 curve
4
-0.43

2
-0.18

D
0
0 10 20 30 40 50
Q
Q (000s)

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5.
• A bus company raised its prices 2 years
ago by 10% in an attempt to cover
increased costs and revenues rose by 5%
• This year it raised its prices again and was
surprised to find that revenue fell by 2%
• The manager was reported as saying “It is
hard to do business when our customers are
so erratic”
• Do you believe that the customers behaved
erratically? Explain your answer. (Hint look
at your answers to Q4)

• Elasticity increases as you move

upwards along a demand curve.
• Consumers may be price inelastic at
lower prices, but if prices are
increased (ceteris paribus) then
eventually demand will become price
elastic
• After this point, revenue will fall when
prices are increased
• So this is not erratic, but is what
economic theory would predict

Question 6
• An executive of a professional
association introduced a motion at the
annual general meeting “to increase
dues by 10% so as to increase our
revenue by 10 per cent”.
• Using the concept of elasticity do you
think his views were over optimistic?
Explain your answer

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• He/she is being very optimistic

• Must be assuming that members of the
association have price elasticity of
demand equal to zero (i.e. perfectly
inelastic)
• Even if they were price inelastic, one
would expect revenue to increase by
less than 10% in this situation

7. Suppose demand and supply are

given by the following equations:

Qd = 110 – 5P
Qs = 6P

• Where: Qd = Quantity demanded, Qs

= Quantity supplied and P = price
a) Using algebra, determine the
market equilibrium price and quantity.

a) Equilibrium price is where

Qd = Qs
110 – 5P = 6P
11P = 110

• So equilibrium price is P = 10

Qd = 110 – 5(10) = 60
Qs = 6 * 10 = 60

• So equilibrium quantity = 60

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b) Find the inverse demand and supply

functions making P the dependent
variable
Inverse demand:
5P = 110 – Qd
P = 22 – 0.2*Qd

Inverse supply:
P = Qs/6

c) Sketch the inverse demand and supply

curves, clearly labelling the slope, the intercept
and the equilibrium price and quantity.
100 Equilibrium P = 10,
Q = 60
Intercept = 22
Slope = 0.167
Slope = 0.2

Price (P) 22 Supply

10

Intercept = 0 Demand

0
0 60 110
Quantity (Q)

d) Calculate elasticity of demand at

the equilibrium price
• From part (a), in equilibrium,
P=10 and Qd=60

• Using the point formula:

= -5 * 10/60
= -0.83 (price inelastic)

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8.
(a) What is the formula for income
elasticity of demand?

(b) Which of the following would you

expect to have a demand which is elastic
with respect to income? (There are more
than one)

(i) Flour Yes / No / Possibly

(ii) Ready-prepared meals for the
microwave Yes / No / Possibly
(iii) Champagne Yes / No / Possibly
(iv) Socks Yes / No / Possibly

(b) Which of the following would you

expect to have a demand which is elastic
with respect to income? (There are more
than one)

(v) Designer jeans Yes / No / Possibly

(vi) Electricity Yes / No / Possibly
(vii) Bus journeys Yes / No /Possibly
(viii) Insurance Yes / No / Possibly