Price Elasticity of Demand
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AP Microeconomics › Price Elasticity of Demand
A corn farmer operates in a perfectly competitive market and can sell any quantity of corn at the prevailing market price of $$\4$$ per bushel. The demand curve faced by this individual farmer is
perfectly elastic.
downward sloping.
perfectly inelastic.
unit elastic.
Explanation
In a perfectly competitive market, individual firms are price takers. This means they face a horizontal demand curve at the market price. A horizontal demand curve signifies perfectly elastic demand, as the firm would sell zero units if it charged a higher price and can sell all it wants at the market price.
If a 10% increase in the price of a smartphone leads to a 20% decrease in the quantity demanded, the price elasticity of demand for smartphones is
$$-2.0$$, and demand is elastic.
$$-0.5$$, and demand is inelastic.
$$-20.0$$, and demand is elastic.
$$-10.0$$, and demand is inelastic.
Explanation
Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. In this case, $$(-20%) / (10%) = -2.0$$. Since the absolute value of the elasticity ($$2.0$$) is greater than 1, demand is elastic.
The price elasticity of demand for a luxury good, such as a diamond necklace, is generally more elastic than the price elasticity of demand for a necessity, such as bread, because
the purchase of a luxury good can be easily postponed when its price rises.
bread has more substitutes available to consumers than a diamond necklace.
the market for necessities is more narrowly defined than the market for luxuries.
consumers spend a smaller proportion of their income on luxury goods.
Explanation
Luxury goods have more elastic demand because they are not essential for daily life. Consumers can easily choose not to buy them or delay the purchase if the price increases. Necessities like bread must be purchased regularly, making their demand less responsive to price changes.
A government wishes to place an excise tax on a good to raise the most tax revenue possible while causing the smallest decrease in the equilibrium quantity. The government should choose a good for which the demand is
unit elastic.
perfectly elastic.
relatively inelastic.
relatively elastic.
Explanation
If demand is inelastic, consumers are not very responsive to price changes. A tax increases the price paid by consumers, but the quantity demanded will fall by a relatively small percentage. This allows the government to collect substantial revenue from the large quantity of the good still being sold.
A local movie theater raises its ticket prices and discovers that its total revenue from ticket sales has increased. This indicates that the demand for its movie tickets is
price elastic.
price inelastic.
perfectly elastic.
unit elastic.
Explanation
The total revenue test states that if price and total revenue move in the same direction (both increase, in this case), the demand for the good is price inelastic. Consumers are not very responsive to the price change, so the higher price outweighs the small drop in quantity demanded.
The owner of a local bookstore wants to increase total revenue. An economic consultant has estimated that the price elasticity of demand for books at this store is -1.8. The consultant should advise the owner to
increase the quantity of books supplied.
decrease the price of books.
increase the price of books.
keep the price of books unchanged.
Explanation
Since the price elasticity of demand is elastic ($$|-1.8| > 1$$), price and total revenue move in opposite directions. To increase total revenue, the owner must decrease the price. The resulting percentage increase in quantity sold will be larger than the percentage decrease in price.
In the immediate aftermath of a sharp increase in electricity prices, most households do not significantly reduce their electricity consumption. Over several years, however, people may install more energy-efficient appliances and insulation. This pattern implies that the price elasticity of demand for electricity is
more elastic in the long run than in the short run.
constant over both the short run and the long run.
perfectly inelastic in the short run and perfectly elastic in the long run.
more inelastic in the long run than in the short run.
Explanation
One of the determinants of price elasticity is the time horizon. Consumers have more time to adjust their behavior and find substitutes or alternatives in the long run. Therefore, demand becomes more responsive to price changes, and thus more elastic, over a longer period.
Suppose the calculated price elasticity of demand for a particular brand of cereal is $$-0.8$$. Which of the following statements is true?
Demand is unit elastic, so any change in price will not affect total revenue.
Demand is price elastic, so an increase in price will lead to a decrease in total revenue.
Demand is price inelastic, so a decrease in price will lead to a decrease in total revenue.
The good is classified as an inferior good because its elasticity coefficient is negative.
Explanation
The absolute value of the elasticity is $$0.8$$, which is less than 1, indicating that demand is price inelastic. According to the total revenue test, if demand is inelastic, price and total revenue move in the same direction. Therefore, a price decrease will cause total revenue to decrease.
A coffee shop lowers the price of its lattes from $$5.00 to $$4.50 and finds that its total revenue from lattes increases. This outcome suggests that over this price range, the demand for its lattes is
inelastic.
unit elastic.
elastic.
perfectly inelastic.
Explanation
According to the total revenue test, if price and total revenue move in opposite directions (price decreased while total revenue increased), the demand for the good must be elastic. The percentage increase in quantity demanded was greater than the percentage decrease in price.
The price elasticity of demand is likely to be greatest for which of the following?
Life-saving heart medication.
All forms of transportation.
All automobiles.
A specific brand of sports car.
Explanation
Price elasticity of demand is higher when the market is more narrowly defined and there are more available substitutes. A specific brand of sports car has many substitutes (other brands, other types of cars), making its demand highly elastic compared to the broader, less substitutable categories of 'all automobiles' or 'all forms of transportation'. Heart medication is a necessity with few substitutes, making it highly inelastic.