- A streaming service that exclusively shows classic films from the 1940s and 1950s decides to double its monthly subscription fee. The service sees a massive drop in subscribers, with over 60% canceling their plans. The demand for this specific streaming service is likely highly elastic primarily because:
Answer: there are many other entertainment substitutes available, from general streaming platforms to free library services.
The large drop in subscribers in response to a price increase is the definition of highly elastic demand. The most plausible reason is the vast number of substitutes. Consumers seeking entertainment have countless other options: major streaming services (Netflix, Hulu), other niche services, YouTube, television, movie rentals, and public libraries. Because these substitutes are readily available, consumers are very sensitive to price changes for a non-essential, niche service.
- A technological innovation allows internet service providers to switch customers between different data plans instantly and without any fees or contracts. How would this innovation most likely affect the price elasticity of demand for a premium, high-speed data plan?
Answer: It would become more elastic because the innovation reduces the cost and difficulty of switching to a substitute (a lower-priced plan).
This question focuses on a nuanced aspect of substitutes: the ease of switching. The innovation effectively makes other data plans (especially cheaper ones) much closer and more accessible substitutes. When it's easy and costless to switch to an alternative, consumers become much more sensitive to price changes for their current plan, thus making demand more elastic.
- Two years ago, a city implemented a complex and expensive permit system for residents who wanted to rent out rooms on short-term rental websites. Which of the following is the most likely effect of this policy on the price elasticity of demand for hotel rooms in the city?
Answer: Demand for hotel rooms became more inelastic, as the policy made it harder for a key substitute (short-term rentals) to operate.
Short-term home rentals are a direct substitute for hotel rooms. By making it more difficult and expensive to offer these rentals, the city's policy effectively reduced the availability and attractiveness of this substitute. When the number of viable substitutes for a good decreases, the demand for that good becomes more inelastic. Travelers have fewer alternatives to hotels, so they become less sensitive to changes in hotel prices.
- A new international trade agreement makes it much easier for foreign car manufacturers to sell their vehicles in the United States. From the perspective of a consumer considering buying a car from a U.S. manufacturer, this agreement will most likely:
Answer: increase the price elasticity of demand for U.S.-made cars.
The trade agreement increases the number and variety of foreign cars available, which are substitutes for U.S.-made cars. When consumers have more substitutes to choose from, their demand for any single option (like U.S.-made cars) becomes more elastic. If U.S. manufacturers raise their prices, consumers can more easily switch to a foreign alternative. Therefore, demand becomes more responsive to price changes.
- The owner of the only gas station in a remote desert town observes that they can significantly raise the price of gasoline without losing many customers. The demand for gasoline at this station is highly inelastic. Which set of determinants best explains this situation?
Answer: Lack of substitutes and a short time horizon for travelers.
The demand is inelastic for two main reasons. First, being the only gas station in a remote area means there are no immediate substitutes available. Drivers cannot easily go elsewhere. Second, a traveler running low on fuel has a very short time horizon; they need gas now and cannot wait to find a cheaper alternative. This combination of no substitutes and urgency makes demand highly inelastic.
- A new prescription drug is introduced to treat a rare, life-threatening disease. The drug has no other therapeutic alternatives. The price elasticity of demand for this drug is expected to be:
Answer: highly inelastic because it is a necessity with no available substitutes.
This scenario combines two key determinants that point to inelastic demand: necessity and lack of substitutes. The drug is a life-saving necessity, meaning patients will be highly motivated to purchase it regardless of price. Furthermore, the absence of any alternatives means consumers cannot switch to another product if the price rises. Both factors contribute to a highly inelastic demand.
- The demand for a specific brand of smartphone is generally more elastic than the demand for smartphones as a broad product category. Which of the following best explains this difference?
Answer: A specific brand has many close substitutes (other brands), whereas the overall category has fewer substitutes.
This question addresses how the definition of a market affects elasticity through the availability of substitutes. A narrowly defined good (a specific brand like an iPhone) has many close substitutes (Samsung, Google phones, etc.). A broadly defined good (smartphones in general) has fewer close substitutes (perhaps feature phones or tablets, which are not perfect substitutes). The more substitutes available, the more elastic the demand.
- All of the following would tend to make the demand for a good more elastic EXCEPT:
Answer: the good is a necessity rather than a luxury.
This question asks to identify the factor that does NOT increase elasticity (i.e., makes it more inelastic). A, B, and C are the three primary determinants of elasticity. More substitutes (B, D), a longer time horizon (C), and the good being a luxury all lead to more elastic demand. A good being a necessity leads to more inelastic demand, as consumers need to buy it regardless of price. Therefore, being a necessity is the exception.
- Which of the following best illustrates why the price elasticity of demand for a product tends to increase as the time period under consideration lengthens?
Answer: Following a sharp increase in electricity prices, consumers gradually replace old appliances with more energy-efficient models.
The time horizon determinant allows consumers to make significant behavioral or technological adjustments. In the short run, people can't do much about high electricity prices besides turning off lights. In the long run, they can make capital investments (new appliances, insulation) that serve as substitutes for high electricity consumption. This ability to adjust and find substitutes over time is why long-run demand is more elastic than short-run demand.
- Assume the price of gasoline rises and stays high for several years. The long-run price elasticity of demand for gasoline is significantly higher than the short-run elasticity. This is primarily because, in the long run, consumers can:
Answer: make significant lifestyle and technology changes, such as buying fuel-efficient cars or moving closer to work.
The time horizon determinant of elasticity is about the ability to adjust behavior and find substitutes. In the short run, a driver must still get to work and has the same car, so they buy gas. In the long run, they can respond to sustained high prices by purchasing a more fuel-efficient or electric vehicle, arranging a carpool, using public transit, or even moving. These are all forms of substitution that are only possible over a longer period, making long-run demand more elastic.
- In the 1990s, high-speed internet was considered a luxury item for most households. Today, it is widely viewed as a necessity for work, education, and communication. This perceptual shift from luxury to necessity would cause the price elasticity of demand for high-speed internet to:
Answer: decrease (become more inelastic).
Goods that are considered necessities have more inelastic demand than goods considered luxuries. A necessity is something consumers feel they must have, regardless of the price. As high-speed internet became essential for daily life, consumers became less willing or able to cut back on it in response to a price increase. This makes demand less sensitive to price, meaning it has become more inelastic (elasticity has decreased).
- For a student who lives on campus without a car, the demand for meals at the university's main dining hall is likely to be highly inelastic. Which of the following changes would cause the student's demand for dining hall meals to become significantly more elastic?
Answer: A new, affordable grocery store and several fast-food restaurants open just off campus, within easy walking distance.
The student's initial demand is inelastic primarily due to a lack of substitutes. The opening of nearby, accessible food alternatives introduces a range of substitutes for the dining hall. With more choices available, the student can easily respond to a price increase at the dining hall by eating elsewhere, making their demand significantly more price-sensitive, or elastic.
- Consider the demand for two goods: table salt and luxury sports cars. A 10% increase in the price of both goods will likely lead to a much larger percentage decrease in the quantity demanded for sports cars than for salt. This difference in elasticity is best explained because:
Answer: a sports car represents a significantly larger proportion of a consumer's income than does table salt.
While sports cars are luxuries and salt is a necessity, a primary reason for the vast difference in elasticity is the proportion of income spent on the good. A 10% price increase on salt might be a few cents, which a consumer would barely notice. A 10% increase on a $100,000 sports car is $10,000, a substantial amount that will cause many potential buyers to reconsider or delay their purchase. Goods that take up a larger share of a consumer's budget tend to have more elastic demand.
- A city government passes a new law requiring all new apartment buildings to include parking, significantly increasing the cost and difficulty of building new housing. Over the next five years, no new apartments are built. How would this situation most likely affect the price elasticity of demand for existing rental apartments in the city?
Answer: It would become more inelastic, because the lack of new construction limits the availability of substitutes for tenants.
The core determinant of demand elasticity being tested is the availability of substitutes. By halting the construction of new apartments, the regulation effectively reduces the number of potential substitutes for existing apartments. When tenants have fewer alternatives to choose from, their demand becomes less responsive to price changes (more inelastic). Landlords have more power to raise prices without losing a significant number of tenants.
- Which of the following describes a situation that would lead to a decrease in the price elasticity of demand for a product?
Answer: A competitor's similar product is removed from the market due to a safety recall.
A decrease in elasticity means demand becomes more inelastic (less responsive to price). This happens when the determinants change to favor inelasticity. The removal of a competing product from the market directly reduces the number of available substitutes. With fewer alternatives, consumers are 'stuck' with the remaining product, making their demand for it less sensitive to price changes.
- If a government wants to impose an excise tax to raise significant revenue while affecting consumer behavior as little as possible, it should target a good for which demand is:
Answer: highly inelastic, because consumers will continue to buy nearly the same quantity even at the higher post-tax price.
This is an application of elasticity concepts. To raise revenue without significantly changing quantity consumed, the government needs to tax a good that people will continue to buy even when the price goes up. This is the definition of a good with inelastic demand. Consumers are not very responsive to the price change, so the quantity sold decreases only slightly, and the government collects tax revenue on a large volume of sales. Common examples include taxes on gasoline and tobacco.
- A concert venue sells tickets for a world-famous pop star's only local performance. A separate venue in the same city sells tickets for a weekly performance by a local jazz band. The demand for the pop star's tickets is likely to be more inelastic than the demand for the jazz band's tickets because:
Answer: the pop star's concert is a unique event with no direct substitutes, while the jazz concert has many substitutes.
The key determinant here is the availability of substitutes. The pop star's concert is a one-time, unique event. For a fan, there is no substitute for seeing that specific artist. The local jazz band, while perhaps excellent, is one of many live music options available any given week in a city. A consumer could choose a different band, go to a movie, or stay home. The uniqueness and lack of close substitutes for the pop star's show make demand for those tickets more inelastic.
- For many years, a single company held a patent for a specific type of insulin, a life-saving medication for diabetics. When the patent expired, several firms entered the market with generic bio-similar versions. This market change would cause the demand curve for the original company's insulin to become:
Answer: more elastic, because consumers now have more nearly identical products to choose from.
The key determinant is the number of substitutes. The entry of generic competitors introduces close substitutes for the original brand-name drug. Even though insulin as a product category has inelastic demand (it's a necessity), the demand for a specific brand of insulin becomes much more elastic when consumers can easily switch to a competitor's identical product if the price is too high.
- Consider a consumer who is diabetic and requires daily insulin injections to live. Now consider a different consumer who enjoys a gourmet coffee from a specific cafe each morning. Which economic concept best explains why the diabetic's demand for insulin is more inelastic than the coffee drinker's demand for their specific coffee?
Answer: Insulin is a medical necessity with no substitutes, whereas the coffee is a non-essential good with many substitutes.
This question directly compares two goods based on the determinants of necessity and substitutes. Insulin is an absolute necessity for survival for the diabetic, and there are no alternatives to it. This makes demand extremely inelastic. The gourmet coffee is a want, not a need, and has numerous substitutes: coffee from a different cafe, making coffee at home, or drinking tea. The combination of being a non-necessity with many substitutes makes its demand elastic.
- In January, the price of home heating oil unexpectedly increases by 40%. In which scenario would the price elasticity of demand for heating oil be the lowest (most inelastic)?
Answer: In February of the same year, for households whose furnaces can only run on heating oil.
This question combines the determinants of time and substitutes. Demand is most inelastic when consumers have little time to react and have few available substitutes. In the short run (February), households with oil-only furnaces have almost no alternative; they must buy the oil to heat their homes. This makes their demand highly inelastic. The other options introduce either substitutes (B) or a longer time horizon (C and D), both of which would increase elasticity.
