- A company invests heavily in an advertising campaign designed to build strong brand loyalty among its customers. A successful campaign would most likely cause the demand for its product to become:
Answer: more price inelastic, as consumers will perceive fewer viable substitutes for the brand.
The goal of brand-loyalty advertising is to make consumers believe that a specific brand is unique and superior to its competitors. If successful, consumers will see fewer close substitutes for the product and will be less sensitive to price changes. A lower sensitivity to price changes means the demand becomes more price inelastic, allowing the firm to potentially raise prices without losing as many customers.
- Suppose the price of salt were to double. For most households, the quantity of salt demanded would likely decrease by only a very small amount. This indicates that the demand for salt is:
Answer: inelastic, primarily because salt represents a very small proportion of a household's total budget.
The demand for salt is highly inelastic for two main reasons: it is a necessity with few substitutes, and it constitutes a very small fraction of a consumer's income. Even if the price doubles (a 100% increase), the absolute dollar amount is minimal, so consumers will barely change their purchasing habits. Therefore, the small response in quantity demanded relative to the large price change signifies inelastic demand.
- It is a common error to confuse the slope of a demand curve with its elasticity. Which statement best clarifies the distinction?
Answer: Slope is constant along a linear demand curve, but elasticity changes at every point along the curve.
For a standard, linear (straight-line) demand curve, the slope (change in price / change in quantity) is constant throughout its length. However, price elasticity of demand is calculated using percentage changes. Because the base values for price and quantity are different at every point on the curve, the elasticity varies. Specifically, demand is elastic in the upper-left portion, unit elastic at the midpoint, and inelastic in the lower-right portion of a linear demand curve. Thus, slope is constant while elasticity changes.
- A single farmer in a perfectly competitive market for soybeans must sell at the prevailing market price of $14 per bushel. If this farmer tries to sell her soybeans for $14.10, her sales will drop to zero. This situation implies that the demand curve facing this individual farmer is:
Answer: perfectly elastic.
In a perfectly competitive market, a single producer is a price taker. They can sell all they want at the market price, but nothing at a higher price because buyers have perfect substitutes (soybeans from thousands of other farmers). An infinitesimally small price increase causes quantity demanded to fall to zero. This describes a horizontal demand curve, which represents perfectly elastic demand.
- An airline knows that business travelers and leisure travelers have different price elasticities of demand for flights. They offer lower prices for tickets that include a Saturday-night stay. This price discrimination strategy is profitable because it:
Answer: charges a lower price to leisure travelers, who have a more elastic demand for air travel.
This pricing strategy separates groups based on their demand elasticity. Business travelers typically need to return home before the weekend and are less sensitive to price (inelastic demand). Leisure travelers are more flexible and price-sensitive (elastic demand). The Saturday-night stay requirement is a way to identify leisure travelers and offer them a lower price, which they are more likely to respond to. The airline charges the less price-sensitive business travelers a higher fare. The strategy works by charging the lower price to the group with more elastic demand.
- A significant increase in the price of gasoline leads to a large decrease in the sales of large, fuel-inefficient SUVs. This secondary effect occurs because, for many consumers, gasoline and SUVs are:
Answer: complementary goods, and the demand for SUVs is price elastic.
This question combines the concept of related goods with elasticity. Gasoline and SUVs are complements; they are often consumed together. When the price of a complement (gasoline) rises, the demand for the related good (SUVs) falls. The fact that the decrease in sales was 'large' suggests that demand for SUVs is responsive to changes in the total cost of ownership (car price + fuel price), which implies price elastic demand. Therefore, they are complementary goods and the demand for SUVs is elastic.
- If a 5% increase in the price of a product leads to a 5% decrease in the quantity demanded, the price elasticity of demand is considered to be:
Answer: unit elastic, and total revenue will remain unchanged.
Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. In this case, it is -5% / +5% = -1. An elasticity coefficient with an absolute value of 1 is defined as unit elastic. According to the total revenue test, when demand is unit elastic, a change in price is exactly offset by the change in quantity demanded, so total revenue does not change.
- A consultant for a public university system, which is facing a budget shortfall, recommends a significant tuition increase. This recommendation implicitly assumes that the demand for education at this university system is:
Answer: relatively inelastic, meaning the percentage decrease in enrollment would be smaller than the percentage increase in tuition.
For a price increase to lead to an increase in total revenue (in this case, tuition revenue), the demand for the good or service must be price inelastic. This means that the quantity demanded (enrollment) will decrease by a smaller percentage than the percentage increase in price (tuition), causing the total revenue to rise.
- The price elasticity of demand is generally greater for 'Coca-Cola' than it is for 'soft drinks' as a product category. The primary reason for this is that:
Answer: the market for Coca-Cola is defined more narrowly, resulting in more available substitutes.
One of the key determinants of price elasticity of demand is the narrowness of the market definition, which relates to the availability of substitutes. The demand for a specific brand (Coca-Cola) is more elastic because there are many close substitutes (Pepsi, other colas, other soft drinks). The demand for the entire product category (soft drinks) is less elastic because the substitutes are less direct (water, juice, coffee).
- Which of the following scenarios describes a good with perfectly inelastic demand?
Answer: A diabetic patient needs a specific dosage of insulin to survive and will pay whatever the market price is to obtain it.
Perfectly inelastic demand occurs when the quantity demanded does not change regardless of the price. The classic example is a life-saving medication. The diabetic patient requires a fixed quantity of insulin to live and will therefore attempt to purchase that amount irrespective of the price. Choice C describes perfectly elastic demand faced by a firm in a competitive market. Choice D describes unit-elastic demand. Choice A describes a willingness to pay up to a certain price, not a fixed quantity at any price.
- In the short run, the price elasticity of demand for gasoline is approximately -0.2. In the long run, it is estimated to be closer to -0.7. What is the most likely reason for this difference?
Answer: Over time, consumers have more opportunities to adjust their behavior and find substitutes.
Price elasticity of demand tends to be higher in the long run because consumers have more time to adjust to price changes. In the short run, a person may have to pay the higher price for gasoline to get to work. In the long run, they can buy a more fuel-efficient car, move closer to work, or arrange carpools. These adjustments are forms of substitution, making demand more elastic (more responsive to price changes) over a longer time horizon. Choice D refers to the elasticity of supply, not demand.
- Based on the information in the passage, which statement accurately compares the price elasticities of demand?
Answer: The demand for coffee is inelastic, while the demand for gourmet cupcakes is elastic.
First, calculate or interpret the elasticity for each good. For coffee, the elasticity is -4% / 10% = -0.4. Since the absolute value (0.4) is less than 1, demand is inelastic. For cupcakes, the elasticity is -12% / 10% = -1.2. Since the absolute value (1.2) is greater than 1, demand is elastic. Therefore, the demand for coffee is inelastic and the demand for cupcakes is elastic.
- A manufacturer of a popular brand of blue jeans discovers that when it lowers its price, its total revenue also falls. This outcome suggests that in this price range, the demand for its jeans is:
Answer: price inelastic.
This question applies the total revenue test. The rule states that if price and total revenue move in the same direction, demand is inelastic. Here, the price was lowered and total revenue also fell. Because they moved in the same direction (down), demand must be price inelastic. This means the percentage increase in quantity sold was not enough to offset the percentage decrease in price.
- Which of the following describes a situation where demand is most likely to be price elastic?
Answer: A new housing development opens, offering homes similar to those in many other nearby developments.
Price elasticity of demand is highest when there are many close substitutes, the good is a luxury, it takes a large portion of income, and there is a long time to decide. The new housing development (B) fits this best, as buyers have many alternatives (other developments, existing homes) and a house is a major expense. The other scenarios describe situations with highly inelastic demand: a necessity with no substitutes (A), a necessity with no substitutes (C), and a unique good with high personal value (D).
- The price elasticity of demand for insulin, a necessary medication for diabetics, is very low, while the price elasticity of demand for a specific brand of designer sunglasses is very high. Which economic principle best explains this difference?
Answer: The availability of close substitutes is a major determinant of price elasticity.
The primary determinant of the difference in elasticity between these two goods is the availability of substitutes. For a diabetic, there are no close substitutes for insulin, making demand highly inelastic. For a specific brand of designer sunglasses, there are many substitutes (other brands of sunglasses, non-designer sunglasses, or no sunglasses), making demand highly elastic. While proportion of income (A) is a determinant, it's not the primary reason here, and for some, sunglasses are more expensive than their insulin copay. (C) and (D) are not direct explanations for price elasticity of demand.
- An economic study determines that the price elasticity of demand for a specific brand of breakfast cereal is -2.5. Which of the following is the most accurate interpretation of this value?
Answer: A 10% decrease in the price of the cereal will lead to a 25% increase in the quantity demanded.
The price elasticity of demand coefficient measures the ratio of the percentage change in quantity demanded to the percentage change in price. An elasticity of -2.5 means that for every 1% change in price, the quantity demanded changes by 2.5% in the opposite direction. Therefore, a 10% decrease in price would lead to a 25% (10% × 2.5) increase in the quantity demanded. Choice B confuses percentage changes with unit changes. Choice D incorrectly interprets the negative sign, which is conventional; the magnitude (2.5 > 1) indicates elastic demand.
- A local movie theater lowers its ticket price from $12 to $10. Consequently, the average number of tickets sold per night increases from 300 to 390. Based on the total revenue test, which of the following is true about the demand for movie tickets in this price range?
Answer: Demand is elastic because the theater's total revenue increased as a result of the price decrease.
This question requires a two-step analysis using the total revenue test. First, calculate total revenue before and after the price change. Initial Total Revenue: $12 × 300 = $3600. New Total Revenue: $10 × 390 = $3900. Second, apply the total revenue test rule. Since the price decreased and total revenue increased (from $3600 to $3900), the demand for movie tickets must be price elastic in this range.
- A bookstore lowers the price of a novel from $20 to $16. Sales increase from 100 to 120 copies per week. Using the simple percentage change method, the demand for this novel is:
Answer: unit elastic, with a coefficient of -1.0.
This question requires calculating the price elasticity of demand coefficient. Percentage change in price = (($16 - $20) / $20) 100 = -20%. Percentage change in quantity demanded = ((120 - 100) / 100) 100 = +20%. The price elasticity of demand is (% change in Qd) / (% change in P) = 20% / -20% = -1.0. An elasticity coefficient of -1.0 is defined as unit elastic. The other options misclassify the type of elasticity or miscalculate the coefficient.
- A city government wants to impose a per-unit tax on a consumer good to raise the maximum possible revenue. The government's economic advisors should recommend taxing a product for which consumer demand is:
Answer: highly inelastic, as the quantity demanded will decrease very little in response to the price increase caused by the tax.
To maximize tax revenue, the government should tax a good where the quantity purchased changes very little when the price rises due to the tax. This describes a good with highly inelastic demand. If demand is inelastic, consumers are not very responsive to price changes, so they will continue to buy nearly the same quantity at the higher (tax-included) price, leading to substantial tax revenue. Taxing a good with elastic demand would cause a large drop in quantity sold, reducing the tax base and leading to lower revenue.
