Tutorial 4 ELASTICITY

Chapter 4Review Questions1. The price elasticity of demand depends on the income of consumers because relative changes, either in the price of the good, or changes in the income, affect the purchasing power of consumers. Furthermore, the share of the income allocated to a specific good, also affects the price elasticity of demand of that product. For example, a drastic increase in the price of salt, a good that accounts for very little share of most peoples income, would not change the quantity demanded by very much, whereas a drastic increase in airfares, which account for a larger share of consumer income, would cause many people to avoid flying during that period of increased fare. This shift in price, causing varying degrees of shifts in quantity changes depending of the type of good in question.2.Due to the price elasticity of demand being proportional to the ratio of price and quantity (P/Q), as we progress down the demand curve, the price decreases while the quantity increases, thus changing the ratio, and decreasing the value of the price elasticity of demand. 3. An increase in the price of a good will decrease the total expenditure on that good whilst that good has an elastic demand, or when elasticity is > 1.4. The price elasticity of demand for a good with respect to its own price ignores the algebraic sign because the sign will always be a negative, and for simplification, the absolute value is used. The reason the sign is always a negative is because the price and quantity of a good always travel in opposite directions, that is, if a price is increased, the quantity will decrease, and vice versa, and so according to the elasticity formula , this will result in a difference of sign between P and Q, resulting in a final negative. However, this is not always the case when taking the elasticity of a good with respect to another good, as a price shift in one good may increase or decrease the quantity of the other good, depending on whether the two goods are substitutes or complements to each other. 5. Supply elasticity is higher in the long term as it represents a more flexible combination of inputs, due to the longer period of time, as opposed to the short run, in which producers may be stuck with whatever inputs they currently have to produce their goods. 6.Because the butter has an elasticity of 0.5 (