Chapter 6 — Exercises
Section A — Computing elasticities
A1. Price rises from $10 to $12. Quantity demanded falls from 100 to 80. Calculate the price elasticity of demand using the midpoint formula. Is this good elastic, inelastic, or unit elastic?
A2. Price falls from $20 to $15. Quantity demanded rises from 50 to 70. Calculate the elasticity. Is the good elastic or inelastic?
A3. A 5% price increase causes quantity demanded to fall by 12%. What is the elasticity? Elastic or inelastic?
A4. A 10% price increase causes quantity demanded to fall by 4%. What is the elasticity? Elastic or inelastic?
A5. A monopolist is selling 100 units at $20. She is considering raising the price to $24 (a 20% increase). Her best estimate of the elasticity at the current price is 0.5. Approximately what would happen to quantity sold? To total revenue?
Section B — Determinants
B1. For each of the following pairs, identify which has more elastic demand and explain why using the four determinants from §6.2: - (a) Salt vs. restaurant meals - (b) Insulin (for type-1 diabetics) vs. Tylenol - (c) Coca-Cola vs. soft drinks (the broad category) - (d) Gasoline next month vs. gasoline ten years from now - (e) Housing vs. matches
B2. Explain why the long-run elasticity of demand for gasoline is much larger than the short-run elasticity. Give three specific things consumers can do in the long run that they cannot easily do in the short run.
B3. Why is the demand for all food much more inelastic than the demand for any specific food?
B4. A high-end restaurant raises its prices by 15%. The owner expects only a slight drop in customers because "people who eat here can afford it." Is the owner thinking about elasticity correctly? What other reason might the elasticity be low at this restaurant?
Section C — Income and cross-price elasticities
C1. As your income rises, you buy more steak and less ramen noodles. What does this tell you about the income elasticity of each good? Which is normal, which is inferior?
C2. A 10% increase in the price of butter causes the quantity of margarine demanded to rise by 8%. What is the cross-price elasticity? Are butter and margarine substitutes or complements?
C3. A 10% increase in the price of cars causes the quantity of gasoline demanded to fall by 3%. What is the cross-price elasticity? Are cars and gasoline substitutes or complements?
C4. Pick a good you regularly buy. Estimate (qualitatively) its price elasticity, income elasticity, and cross-price elasticity with two related goods. Justify each estimate.
Section D — Supply elasticity
D1. Why is the price elasticity of supply almost always larger in the long run than in the short run? Give three real-world examples of industries where this is the case.
D2. Beachfront real estate has very inelastic supply. Why? What does this imply for the effect of demand changes on beachfront prices?
D3. Suppose the demand for a good rises sharply. What happens to the price (a) in the short run, when supply is inelastic, vs. (b) in the long run, when supply is more elastic? Sketch the two scenarios.
Section E — Tax incidence
E1. A tax of $1 per pack is imposed on cigarettes. Demand for cigarettes is highly inelastic; supply is elastic. Predict approximately who bears the burden of the tax — consumers or producers? How much of the $1 ends up as a higher price for consumers?
E2. A tax of $200 per yacht is imposed on luxury yachts. Demand for yachts is highly elastic; supply is inelastic (specialized boatbuilders). Predict who bears the burden. What real-world episode does this resemble?
E3. "If we want the rich to pay for a new program, we should tax luxury goods." Use the elasticity-of-incidence principle to evaluate this idea. Where does it work, and where does it fail?
E4. Why might a tax that is legally collected from sellers actually be paid by buyers in practice?
Section F — Total revenue
F1. A coffee shop is considering raising the price of a latte from $5 to $6. The owner estimates her customers' demand for lattes has an elasticity of 0.4 (inelastic). Should she raise the price? Why?
F2. A different coffee shop has demand elasticity of 1.8 (elastic) at the current price. Should the owner raise prices? Lower prices? Hold prices steady?
F3. Why might a museum charge admission far below its cost (or even free) if its goal is total revenue maximization? (Hint: think about the elasticity of demand for museum visits, and what it means for the museum's other revenue sources like donations and gift shop sales.)
Section G — Data lookup
G1. Look up estimates of the price elasticity of demand for one of the following goods: gasoline, cigarettes, alcohol, electricity, soda. (Search for "price elasticity of demand" + the good in academic literature or government reports.) What did you find? Compare the short-run and long-run estimates if both are available.
G2. The CBO has published estimates of the labor demand elasticity for minimum-wage workers. Look up the most recent CBO report on the minimum wage. What elasticity does the CBO use, and how does that translate into a predicted employment effect for a $15 federal minimum wage?
Section H — Policy debate
H1. "We should impose a carbon tax to reduce greenhouse gas emissions." Apply elasticity to evaluate this proposal. What is the short-run elasticity of demand for fossil fuels? The long-run elasticity? What does this imply for how the carbon tax would work in practice?
H2. "Soda taxes don't reduce soda consumption; they just hurt poor people." Use elasticity to evaluate the claim. What evidence would help you decide whether the claim is right?
H3. "Higher gasoline taxes hurt the poor more than the rich because gasoline is a larger share of poor people's budgets." Use the budget-share determinant to evaluate this claim. Is it correct?
Section I — Reflection
- Of the four determinants of elasticity, which do you find easiest to understand intuitively? Which is hardest?
- Pick a market in your own life. Estimate (qualitatively) the price elasticity of demand. Justify the estimate.
- Have you ever been surprised by how much (or how little) demand for something responded to a price change? What was the situation, and what was the elasticity in retrospect?
Selected answers in appendices/answers-to-selected.md.