Ch 03 answers to questions

Chapter 3: Answers to questions for review

Chapter 3: Answers to questions for review
3.3
[10 marks] It is commonly believed that a producer of a good will increase total revenue by increasing the price of the good produced. Do you agree? Explain, using diagrams in your answer.
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In Figure 3.5(c), the demand curve is unit elastic throughout, and total revenue remains unchanged asprice changes.

3.5

Explain that total revenue is equal to price of a good times quantity of the good sold. Explain that what happens to total revenue in response to an increase in price depends on the price elasticity of demand (PED) for the good. Define price elasticity of demand, and explain the meaning of elastic demand (PED > 1), inelastic demand (PED < 1) and unit elastic demand (PED =1). If PED > 1, price and total revenue change in opposite directions, so an increase in the price of a good leads to a fall in total revenue. If PED < 1, price and total revenue change in the same direction, so an increase in the price of a good leads to an increase in total revenue. If PED = 1, total revenue is unaffected by a change in price. The effects of a price increase on total revenue canbe shown in diagrams, as in Figure 3.5. Explain that the PED changes along a straightline demand curve; so that PED > 1 in the upper left portion, PED < 1 in the bottom right portion, and PED = 1 at the mid-point of the demand curve. To show the effects of a price increase when PED > 1, draw a diagram like Figure 3.5(a), where the relevant prices are in the upper left portion of the demand curve.At price P1, the firm’s total revenue is P1 × Q1, and is equal to the rectangles A + B. If price increases to P2, total revenue is P2 × Q2, which is equal to A + C. Since A + C < A + B, total revenue has fallen due to the price increase. In Figure 3.5(b), the relevant prices are at the bottom right of the demand curve, where PED < 1.At P1, total revenue is P1 × Q1, which is A + B. If priceincrease to P2, total revenue is P2 × Q2, which is equal to A + C. Since A + C > A + B, total revenue increases as a result of the price increase.

[15 marks] The price of meat increases by 10%, the quantity demanded of meat falls by 12% and the demand for fish increases by 9%. (a) What is the price elasticity of demand for meat? (b) What is the cross-elasticity of demand between meat and fish? (c)What can you conclude about the demand for meat (is it price elastic or inelastic)? (d) What can you conclude about the relationship between meat and fish? (e) Using appropriate diagrams, illustrate the impact of the increase in the price of meat on the quantity of meat demanded and the demand for fish. (a) What is the price elasticity of demand for meat?
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lDefine the price elasticity of demand (PED), and use the formula to calculate it; it is 1.2.

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(b) What is the cross-elasticity of demand between meat and fish?
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Define the cross-elasticity of demand (CED), and use the formula to calculate it; it is + 0.9; a 10% increase in the price of meat results in a 9% increase in the demand for fish.

(c) What can you conclude about thedemand for meat (is it price elastic or inelastic)?
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If PED > 1, then the demand for the good is elastic; since the PED for meat is 1.2, the demand for meat is elastic.

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(d) What can you conclude about the relationship between meat and fish?
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When the CED between two goods is positive (CED > 0), then the two goods are substitutes; this means that an increase in the price of onegood leads to an increase in the demand for the other good.

© Cambridge University Press, 2009

EconomicsfortheIBDiploma 1

Chapter 3: Answers to questions for review
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Define substitutes as two (or more) goods that satisfy a similar need. Since the CED between meat and fish is + 0.9 (PED > 0), meat and fish are substitutes.

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Which elasticity of demand concept is...