Chapter 4 Demand And Elasticity Worksheet

Chapter 4: Demand and Elasticity – A Comprehensive Worksheet Guide

Understanding demand and elasticity is crucial for success in economics and business. This comprehensive guide serves as a detailed worksheet solution for Chapter 4, covering key concepts, calculations, and real-world applications. We'll explore the intricacies of demand curves, price elasticity of demand, income elasticity, cross-price elasticity, and more. By the end, you'll be well-equipped to tackle any problem related to demand and elasticity.

Section 1: Understanding Demand

1.1 Defining Demand:

Demand refers to the consumer's desire and ability to purchase a good or service at a given price during a specific time period. It's crucial to remember that demand isn't just desire; it necessitates both the willingness and the financial capacity to buy.

1.2 The Law of Demand:

The Law of Demand states that, all other factors being equal ( ceteris paribus), as the price of a good increases, the quantity demanded decreases, and vice versa. This inverse relationship is graphically represented by a downward-sloping demand curve.

1.3 Factors Affecting Demand:

Several factors beyond price influence the demand for a product. These include:

• Consumer Income: A rise in income usually leads to higher demand for normal goods, while demand for inferior goods decreases.
• Prices of Related Goods: The demand for a good can be affected by the prices of substitutes (goods that can be used in place of each other) and complements (goods that are consumed together). An increase in the price of a substitute increases demand for the original good, while an increase in the price of a complement decreases demand for the original good.
• Consumer Tastes and Preferences: Changes in fashion, trends, or consumer preferences directly impact demand. A popular new product will see a surge in demand, while an outdated product might experience a decline.
• Consumer Expectations: Anticipated future price changes or shortages can influence current demand. For example, if consumers expect a price increase, they may buy more now.
• Number of Buyers: A larger market size generally leads to higher overall demand.

1.4 Demand Schedule vs. Demand Curve:

A demand schedule is a table showing the quantity demanded at various price points. A demand curve is a graphical representation of this schedule, plotting price on the vertical axis and quantity demanded on the horizontal axis.

Section 2: Price Elasticity of Demand

2.1 Defining Price Elasticity of Demand: Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in price. It's calculated as the percentage change in quantity demanded divided by the percentage change in price:

PED = (% Change in Quantity Demanded) / (% Change in Price)

2.2 Interpreting PED Values:

• |PED| > 1: Elastic demand – a small price change leads to a relatively large change in quantity demanded.
• |PED| < 1: Inelastic demand – a price change results in a relatively small change in quantity demanded.
• |PED| = 1: Unitary elastic demand – the percentage change in quantity demanded equals the percentage change in price.
• PED = 0: Perfectly inelastic demand – quantity demanded does not respond to price changes (e.g., life-saving medication).
• PED = ∞: Perfectly elastic demand – any price increase eliminates demand.

2.3 Factors Affecting Price Elasticity of Demand:

• Availability of Substitutes: Goods with many close substitutes tend to have more elastic demand.
• Necessity vs. Luxury: Necessities have inelastic demand, while luxuries have elastic demand.
• Proportion of Income: Goods that represent a small portion of a consumer's income have inelastic demand.
• Time Horizon: Demand is more elastic in the long run than in the short run, as consumers have more time to adjust their consumption habits.

2.4 Calculating PED:

Let's illustrate with an example. Suppose the price of a good increases from $10 to $12, causing quantity demanded to fall from 100 units to 80 units.

• % Change in Quantity Demanded: [(80-100)/100] * 100% = -20%
• % Change in Price: [(12-10)/10] * 100% = 20%
• PED: -20%/20% = -1 (The negative sign indicates the inverse relationship; the absolute value is used for interpretation.) This indicates unitary elastic demand.

Section 3: Other Elasticities of Demand

3.1 Income Elasticity of Demand (YED):

YED measures the responsiveness of quantity demanded to a change in consumer income.

YED = (% Change in Quantity Demanded) / (% Change in Income)

• YED > 0: Normal good (demand increases with income).
• YED < 0: Inferior good (demand decreases with income).
• 0 < YED < 1: Necessity (demand increases proportionally less than income).
• YED > 1: Luxury (demand increases proportionally more than income).

3.2 Cross-Price Elasticity of Demand (XED):

XED measures the responsiveness of quantity demanded of one good to a change in the price of another good.

XED = (% Change in Quantity Demanded of Good A) / (% Change in Price of Good B)

• XED > 0: Substitutes (an increase in the price of Good B increases demand for Good A).
• XED < 0: Complements (an increase in the price of Good B decreases demand for Good A).
• XED = 0: Unrelated goods.

Section 4: Applications and Real-World Examples

Understanding elasticity is crucial for businesses in making pricing decisions. Firms with inelastic demand products (like gasoline or prescription drugs) can raise prices without significantly impacting quantity demanded, thus increasing revenue. Conversely, businesses with elastic demand products need to be cautious about price increases, as this could dramatically reduce sales.

Government policies also utilize elasticity concepts. Taxes on inelastic goods (like cigarettes) generate significant revenue, while taxes on elastic goods could lead to reduced consumption and lower revenue.

Analyzing different market situations, including monopolies, oligopolies, and perfectly competitive markets, requires a firm grasp of demand and elasticity principles.

Section 5: Practice Problems and Solutions

Problem 1: The price of coffee increases from $3 to $4 per pound, and the quantity demanded falls from 1000 pounds to 800 pounds. Calculate the price elasticity of demand. Is demand elastic, inelastic, or unitary elastic?

Solution 1:

• % Change in Quantity Demanded: [(800-1000)/1000] * 100% = -20%
• % Change in Price: [(4-3)/3] * 100% = 33.33%
• PED: -20%/33.33% ≈ -0.6

Demand is inelastic (|PED| < 1).

Problem 2: If the income of consumers increases by 10% and the demand for a certain good increases by 5%, what is the income elasticity of demand? Is this a normal good, inferior good, necessity, or luxury?

Solution 2:

• YED: 5%/10% = 0.5

This is a normal good (YED > 0) and a necessity (0 < YED < 1).

Problem 3: The price of tea increases by 15%, causing the demand for coffee to increase by 10%. What is the cross-price elasticity of demand? Are tea and coffee substitutes or complements?

Solution 3:

• XED: 10%/15% ≈ 0.67

Tea and coffee are substitutes (XED > 0).

Section 6: Conclusion

This comprehensive worksheet guide provides a thorough understanding of demand and elasticity. Mastering these concepts is essential for analyzing market behavior, making informed business decisions, and understanding the impact of government policies. By understanding the different types of elasticity and their determinants, you can accurately predict how changes in price, income, and related goods will affect the quantity demanded of a product. Remember to practice consistently to solidify your understanding and prepare for more advanced economic concepts. Further exploration of supply and market equilibrium will build upon this foundation.