Key Concepts
Discussion and Review Questions
Learning Objective 5.1 Measure the responsiveness of the quantity demanded to price changes, using the price elasticity of demand.
Provide some examples of goods or services that you purchase that have relatively inelastic demand. How would you respond to a 10% increase in price? Are there any goods that you would consider perfectly inelastic?
What impact has access to the internet on smartphones had on the price elasticity of demand for items from Best Buy or Barnes and Noble? What are some strategies these companies could take to combat any negative impacts?
Learning Objective 5.2 Understand how demand elasticity shapes your total revenue and your business strategy.
You are a pricing manager at a pharmaceutical company. The CEO of the company calls a meeting of all managers to explain that it is critical to increase revenue soon or you may have to start laying off employees. You know that the absolute value of the price elasticity of your leading patented drug is about 0.5. What are some possible changes you could suggest to the CEO to increase revenue?
Learning Objective 5.3 Assess the responsiveness of demand to income, and the prices of other goods.
What are some examples of pairs of goods or services you purchase that are complements or substitutes? Would their cross-price elasticity be positive or negative, and why? What would happen to your purchasing decisions if the price of one of the goods decreased by 50%?
What are some examples of things you purchase that have positive or negative income elasticities? How would your purchase decisions change if your income rose by 20%?
Learning Objective 5.4 Measure the responsiveness of the quantity supplied to price changes, using the price elasticity of supply.
Consider two different companies. The first has a relatively inelastic supply curve; the second has a relatively elastic supply curve. What factors might lead to the difference in supply elasticities between these two businesses? Can you envision an example for each type of company?
Study Problems
Learning Objective 5.1 Measure the responsiveness of the quantity demanded to price changes, using the price elasticity of demand.
In 2017, Hurricane Irma had a significant, negative impact on the orange harvest in Florida. The U.S. Department of Agriculture predicted that the quantity of oranges produced would be 21% lower than the previous year. If the price elasticity of demand for oranges is
The EpiPen is a life-saving device used by people with severe allergies. The U.S. manufacturer of the EpiPen raised its price by nearly 25% per year for nearly a decade. For each price increase of 25%, would quantity demanded change by more or less than 25%?
Europe has eight different companies selling devices similar to the EpiPen. If these devices were available in the U.S. market, what would happen to the price elasticity of demand for the EpiPen?
Learning Objective 5.2 Understand how demand elasticity shapes your total revenue and your business strategy.
An article in Forbes noted that the Intercounty Connector toll road that connects two counties in Maryland was not generating as much toll revenue as predicted. At that time, the toll rate was $8 for a passenger car making a round trip from end to end on the tollway during rush hour. What type of additional information would you need to know in order to determine if the toll should be increased or decreased to maximize revenue?
Suppose an experiment is conducted that provides the data in the accompanying table. What is the price elasticity of demand for using the tollway when the price falls from $8 to $6 (use the midpoint method). Is it elastic or inelastic? Finally, calculate the change in toll revenue when the toll rate changes. Which rate should the toll road charge if the government wants more toll revenue?
Toll rate Number of vehicles using the tollway per day $8 10,000 $6 12,000 People differ in their willingness to pay for air travel and airlines would like to charge different prices to different people. Airlines typically attempt to divide passengers into two types: leisure travelers and business travelers. Suppose that an airline is charging $400 per ticket for all passengers on flights between New York and Washington, D.C. The accompanying tables provide information on quantity demanded for air travel for leisure travelers and business travelers.
Leisure travelers Price per ticket Quantity of tickets per flight $400 100 $500 50 Business travelers Price per ticket Quantity of tickets per flight $400 100 $500 90 Using the midpoint method, calculate and describe the price elasticity of demand for both types of passengers if the airline increases prices to $500. Calculate the change in total revenue for each group.
Learning Objective 5.3 Assess the responsiveness of demand to income, and the prices of other goods.
The average price of gasoline in the United States rose by 17% between 2007 and 2008. The number of extremely large, gas-guzzling vehicles called Hummers sold in the United States fell by 50% over the same period. Use these values to calculate the cross-price elasticity between gasoline and Hummers.
We often observe that items such as different brands of aspirin, gasoline, and tomato sauce are typically priced the same, particularly when consumers can find these goods in close proximity to each other (such as gas stations on opposite sides of the street, or products next to each other on the same grocery store shelf). What does this indicate about the cross-price elasticity of demand for the different brands of the same product? Would you expect the cross-price elasticity to be relatively large or small in magnitude? Positive or negative?
In 2015, Netflix increased its monthly price for new subscribers by $1. In response, someone tweeted: “So tired of being a college student. Can’t wait until I have a stable job and won’t have a meltdown cause Netflix raised their price by $1.” What does this statement indicate about the income elasticity of demand for Netflix for this student? Is it normal or inferior?
Learning Objective 5.4 Measure the responsiveness of the quantity supplied to price changes, using the price elasticity of supply.
The accompanying table shows how many Veggie Delite sandwiches Subway might be willing to sell each day at two different prices. Using the midpoint formula, calculate the price elasticity of supply when price increases from $5.00 to $7.50. Is the price elasticity of supply relatively elastic or inelastic? Suppose that Subway wishes to analyze what happens annually instead of daily. What would happen to its estimated supply curve; would it become relatively steeper or flatter?
Price per sandwich Quantity supplied $5.00 200,000 $7.50 210,000