Microeconomics Quiz: Other Elasticities
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Other ElasticitiesQuestion 1 of 20

A ride-sharing company analyzes demand patterns and finds that the cross-price elasticity of demand between their premium service and standard service is -0.8, while the cross-price elasticity between their standard service and public transportation is +1.2. If the company increases the price of their premium service by 20%, what is the expected net effect on total ride-sharing revenue?

Revenue will definitely increase because premium service has inelastic demand and the cross-price effect will boost standard service demand
Revenue will definitely decrease because the negative cross-price elasticity indicates premium and standard services are complements
The net effect is ambiguous without knowing the price elasticity of demand for each service and their relative revenue contributions
Revenue will remain unchanged because the cross-price effects between premium and standard services will exactly offset each other
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Microeconomics Quiz

Microeconomics Quiz: Other Elasticities

Practice Other Elasticities in Microeconomics with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Other Elasticities, giving you a quick way to practice the rules, question types, and explanations that matter most for Microeconomics.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

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Question 1

A ride-sharing company analyzes demand patterns and finds that the cross-price elasticity of demand between their premium service and standard service is -0.8, while the cross-price elasticity between their standard service and public transportation is +1.2. If the company increases the price of their premium service by 20%, what is the expected net effect on total ride-sharing revenue?

  1. Revenue will definitely increase because premium service has inelastic demand and the cross-price effect will boost standard service demand
  2. Revenue will definitely decrease because the negative cross-price elasticity indicates premium and standard services are complements
  3. The net effect is ambiguous without knowing the price elasticity of demand for each service and their relative revenue contributions (correct answer)
  4. Revenue will remain unchanged because the cross-price effects between premium and standard services will exactly offset each other
Explanation: The negative cross-price elasticity (-0.8) between premium and standard services indicates they are complements within the company's offerings. A 20% price increase in premium service will reduce standard service demand by 16% (20% × 0.8). However, to determine the net revenue effect, we need: (1) the own-price elasticity of premium service to know how its quantity changes, (2) the relative revenues from each service, and (3) potentially the price elasticity of standard service. Choice A makes unsupported assumptions about elasticity. Choice B correctly identifies the complement relationship but draws wrong conclusions. Choice D assumes perfect offsetting without justification.

Question 2

An economist studying housing markets finds that when household income rises by 10%, the demand for apartments increases by 5%, while demand for single-family homes increases by 15%. Additionally, when apartment rents increase by 8%, the demand for single-family homes increases by 4%. What can be concluded about the income and cross-price elasticities in this market?

  1. Apartments have income elasticity of 0.5, homes have income elasticity of 1.5, and the cross-price elasticity is 0.5, indicating apartments and homes are substitutes
  2. Apartments have income elasticity of 0.5, homes have income elasticity of 1.5, and the cross-price elasticity is 0.5, indicating apartments are necessity goods while homes are luxury goods
  3. Both conclusions in choices A and B are correct; apartments and homes are substitutes, with apartments being necessity goods and homes being luxury goods (correct answer)
  4. The cross-price elasticity calculation is incorrect because it should measure homes' price effect on apartment demand, not the reverse
Explanation: Income elasticity calculations: apartments = 5%/10% = 0.5, homes = 15%/10% = 1.5. Cross-price elasticity = 4%/8% = 0.5. Since income elasticities are positive, both are normal goods. Since apartments' elasticity < 1, they're necessities; since homes' elasticity > 1, they're luxuries. The positive cross-price elasticity indicates they're substitutes. Both the substitute relationship (choice A) and the necessity/luxury classification (choice B) are correct. Choice D is incorrect because cross-price elasticity can be calculated in either direction (though the values may differ).

Question 3

A grocery chain analyzes purchase data and finds that when the price of brand-name cereal increases by 15%, sales of store-brand cereal increase by 12%, while sales of oatmeal increase by only 3%. However, when milk prices increase by 20%, sales of both brand-name and store-brand cereals decrease by 8% each. What do these cross-price elasticities suggest about consumer substitution patterns?

  1. Store-brand cereal and oatmeal are both substitutes for brand-name cereal, but store-brand is a closer substitute with elasticity of 0.8 versus 0.2 for oatmeal
  2. All cereals are complements to milk with identical cross-price elasticity of -0.4, indicating similar consumption patterns across cereal types
  3. The data shows that consumers view cereal as an inferior good since demand decreases when milk prices increase significantly
  4. Store-brand cereal is a closer substitute for brand-name cereal than oatmeal is, and all cereals are complements to milk with equal sensitivity (correct answer)
Explanation: When analyzing consumer behavior, cross-price elasticity of demand reveals whether goods are substitutes (positive elasticity) or complements (negative elasticity). The magnitude tells you how strong the relationship is. Let's calculate the cross-price elasticities from this data. When brand-name cereal prices rise 15%, store-brand cereal sales increase 12%, giving a cross-price elasticity of +0.8 (12%/15%). For oatmeal, it's +0.2 (3%/15%). Both positive values confirm these are substitutes for brand-name cereal, but store-brand is much closer (0.8 vs 0.2). When milk prices rise 20%, both cereal types fall 8%, yielding identical cross-price elasticities of -0.4 (8%/20%), confirming cereals and milk are complements with equal sensitivity. Choice A correctly identifies the substitute relationships and elasticity values but fails to mention the complementary relationship with milk. Choice B correctly notes the identical complement relationship with milk but ignores the substitute analysis between cereals. Choice C misinterprets the data entirely—the decrease in cereal demand when milk prices rise indicates complementarity, not that cereal is an inferior good (which relates to income changes, not cross-price effects). Choice D captures both key insights: store-brand cereal is a closer substitute for brand-name than oatmeal, and all cereals show equal complementarity with milk. Study tip: Always calculate the actual cross-price elasticity values (% change in quantity of good A / % change in price of good B) and remember that positive means substitutes, negative means complements, and larger absolute values mean stronger relationships.

Question 4

A consumer's income increases from $60,000 to $75,000, and her consumption of restaurant meals increases from 48 meals per year to 60 meals per year. During the same period, her consumption of frozen dinners decreases from 120 meals per year to 96 meals per year. What are the income elasticities of demand for restaurant meals and frozen dinners, respectively?

  1. Restaurant meals: 1.0, Frozen dinners: -0.8; both are normal goods since elasticities are less than 1 in absolute value
  2. Restaurant meals: 1.0, Frozen dinners: -0.8; restaurant meals are normal goods and frozen dinners are inferior goods (correct answer)
  3. Restaurant meals: 0.8, Frozen dinners: -1.0; restaurant meals are normal goods and frozen dinners are inferior goods
  4. Restaurant meals: 1.25, Frozen dinners: -0.8; restaurant meals are luxury goods and frozen dinners are inferior goods
Explanation: Income elasticity = (% change in quantity demanded)/(% change in income). Income change: (75,000-60,000)/60,000 = 25%. Restaurant meals: quantity change = (60-48)/48 = 25%, so elasticity = 25%/25% = 1.0. Frozen dinners: quantity change = (96-120)/120 = -20%, so elasticity = -20%/25% = -0.8. Restaurant meals have positive income elasticity (normal good), frozen dinners have negative income elasticity (inferior good). Choice A incorrectly classifies frozen dinners as normal. Choice C has calculation errors. Choice D incorrectly calculates restaurant meal elasticity and misclassifies it as luxury (which requires elasticity > 1).

Question 5

An airline company operates both business class and economy class services on the same routes. Market research reveals the following elasticity data: the cross-price elasticity of business class demand with respect to economy class prices is +0.3, while the cross-price elasticity of economy class demand with respect to business class prices is +0.1. The income elasticity of demand is +2.1 for business class and +0.6 for economy class.

Based on the elasticity data provided in the passage, if the airline wants to maximize revenue during a recession when consumer incomes are falling, which pricing strategy would be most effective?

  1. Reduce business class prices significantly to increase demand, since the high income elasticity means business travelers are very price-sensitive
  2. Increase economy class prices while maintaining business class prices, since economy demand is less sensitive to business class price changes
  3. Increase both prices equally to offset the volume decline from falling incomes, since the cross-price elasticities are both positive
  4. Focus on economy class with competitive pricing and reduce business class capacity, since economy class is less affected by income declines (correct answer)
Explanation: When you encounter elasticity problems involving multiple market segments during economic downturns, focus on how income changes affect each segment differently and consider operational flexibility. During a recession, falling incomes will significantly reduce business class demand since it has a high income elasticity of +2.1 (luxury good), meaning a 1% income drop causes a 2.1% demand decrease. Economy class, with an income elasticity of +0.6 (normal good), experiences much smaller demand reductions. The cross-price elasticities (+0.3 and +0.1) confirm these are substitute goods, but the substitution effects are relatively weak. Option D correctly recognizes that economy class becomes the primary revenue driver during recessions. Competitive economy pricing maintains volume in the more stable segment, while reducing business class capacity cuts costs on the segment experiencing severe demand decline. Option A misinterprets income elasticity as price sensitivity - high income elasticity means business demand is very sensitive to income changes, not price changes. Price cuts can't offset the income-driven demand collapse effectively. Option B ignores that raising economy prices during a recession when that segment is your most stable revenue source would drive away price-conscious customers who are your primary remaining market. Option C fails to recognize that equal price increases would disproportionately hurt the economy segment that's keeping the airline viable, while the business segment is already suffering from income effects. Remember: during economic downturns, focus your strategy on the market segment with lower income elasticity - it's your most reliable revenue source when incomes fall.

Question 6

A smartphone manufacturer observes that when consumer incomes increase by 8%, demand for their basic model decreases by 4%, while demand for their premium model increases by 12%. If the company's revenue split is currently 60% basic models and 40% premium models, and both models have the same profit margin per unit, which strategic pricing decision would be most beneficial during an economic expansion?

  1. Increase prices on basic models since they have inelastic demand, which will boost overall revenue without affecting premium model sales
  2. Focus marketing and production capacity on premium models since they are luxury goods with higher income elasticity and will experience stronger demand growth (correct answer)
  3. Maintain current pricing but reduce production of basic models since they are inferior goods that will face declining demand during income growth
  4. Increase prices on both models equally since the positive income growth will offset any negative price effects on quantity demanded
Explanation: Income elasticity for basic model = -4%/8% = -0.5 (inferior good), premium model = 12%/8% = 1.5 (luxury good). During economic expansion with rising incomes, demand for basic models will decline while premium model demand will grow strongly. Choice B correctly identifies focusing on premium models as the best strategy since they're luxury goods with high income elasticity. Choice A confuses income elasticity with price elasticity. Choice C correctly identifies basic models as inferior but suggests reducing production without considering the opportunity to shift resources to premium models. Choice D ignores the different income elasticities and their implications.

Question 7

A coffee shop chain notices that when they increase the price of coffee by 12%, sales of pastries decrease by 9%. However, when a competing chain increases their coffee prices by 10%, this coffee shop's pastry sales increase by 6%. What do these cross-price elasticities reveal about market relationships?

  1. Coffee and pastries are complements with cross-price elasticity of -0.75, while this chain's pastries and competitors' coffee are substitutes with elasticity of 0.6 (correct answer)
  2. Coffee and pastries are substitutes with cross-price elasticity of 0.75, while this chain's pastries and competitors' coffee are complements with elasticity of -0.6
  3. Both relationships show complementary goods since pastry demand changes in response to coffee price changes in both scenarios
  4. The negative relationship indicates inferior goods, while the positive relationship indicates normal goods within the pastry category
Explanation: First relationship (own chain): when coffee price increases 12%, pastry sales decrease 9%. Cross-price elasticity = -9%/12% = -0.75. The negative sign indicates coffee and pastries are complements. Second relationship: when competitor's coffee price increases 10%, this chain's pastry sales increase 6%. Cross-price elasticity = 6%/10% = 0.6. The positive sign indicates the competitor's coffee and this chain's pastries are substitutes (customers switch from expensive competitor coffee to this chain's coffee-pastry combination). Choice B has the signs wrong. Choice C misses the substitute relationship. Choice D confuses cross-price elasticity with income elasticity.

Question 8

A luxury car dealership notices that when gasoline prices rise by 30%, sales of their fuel-efficient hybrid models increase by 12%, while sales of their high-performance sports cars decrease by 18%. Additionally, when local household incomes rise by 15%, hybrid sales increase by 9% and sports car sales increase by 24%. What can be concluded about the elasticity relationships for these vehicle types?

  1. Both vehicle types are luxury goods since they have positive income elasticities, with sports cars showing higher income sensitivity at 1.6 versus 0.6 for hybrids
  2. Hybrids are necessity goods and sports cars are luxury goods, with cross-price elasticities of 0.4 and -0.6 respectively relative to gasoline prices
  3. Sports cars are luxury goods with higher income and gasoline price sensitivity, while hybrids are normal necessity goods that serve as substitutes for gasoline consumption (correct answer)
  4. The negative relationship between gasoline prices and sports car sales indicates these are inferior goods, while hybrids are normal goods
Explanation: Income elasticities: hybrids = 9%/15% = 0.6 (normal good, necessity since <1), sports cars = 24%/15% = 1.6 (luxury good since >1). Cross-price elasticities with gasoline: hybrids = 12%/30% = 0.4 (substitutes - higher gas prices increase hybrid demand), sports cars = -18%/30% = -0.6 (complements - higher gas prices decrease sports car demand, likely due to high fuel consumption). Choice C correctly identifies all relationships. Choice A misses the necessity/luxury distinction and ignores gas price effects. Choice B has correct classifications but doesn't explain the economic logic. Choice D confuses cross-price elasticity with income elasticity in defining inferior goods.

Question 9

A luxury hotel chain observes that when the price of economy hotel rooms in the same market increases by 15%, the demand for their luxury rooms increases by 9%. However, when the price of vacation rentals (Airbnb-style accommodations) increases by 12%, the demand for their luxury rooms increases by only 3%. What can be concluded about the relationship between these accommodations?

  1. Economy hotels are closer substitutes for luxury hotels than vacation rentals are, with cross-price elasticities of 0.6 and 0.25 respectively (correct answer)
  2. Vacation rentals are closer substitutes for luxury hotels than economy hotels are, with cross-price elasticities of 0.25 and 0.6 respectively
  3. Both economy hotels and vacation rentals are complements to luxury hotels since all cross-price elasticities are positive values
  4. The luxury hotel has inelastic demand since the percentage changes in quantity are smaller than price changes in both cases
Explanation: Cross-price elasticity of demand measures how responsive the quantity demanded of one good is to price changes in another good. For luxury hotels vs. economy hotels: (9%/15%) = 0.6. For luxury hotels vs. vacation rentals: (3%/12%) = 0.25. Since both are positive, these are substitute goods. The higher cross-price elasticity (0.6) indicates economy hotels are closer substitutes for luxury hotels than vacation rentals are. Choice B reverses the elasticity values. Choice C incorrectly identifies them as complements (complements would have negative cross-price elasticity). Choice D confuses cross-price elasticity with own-price elasticity.

Question 10

A consulting firm estimates that for a particular brand of instant coffee, the income elasticity of demand is -0.4 and the cross-price elasticity of demand with respect to fresh-brewed coffee is +0.8. Which of the following marketing strategies would be most effective for the company based on this information?

  1. Lobbying for government subsidies on fresh-brewed coffee beans to boost its own sales.
  2. Targeting high-income consumers with premium-focused advertising campaigns.
  3. Focusing promotional efforts during periods of economic downturn or stagnant wage growth. (correct answer)
  4. Positioning the product as a complementary good to be consumed with fresh-brewed coffee.
Explanation: An income elasticity of -0.4 means the instant coffee is an inferior good; demand for it increases as consumer income falls. Therefore, the product will sell better during economic downturns. The positive cross-price elasticity of +0.8 indicates it is a substitute for fresh-brewed coffee, not a complement. Targeting high-income consumers is inconsistent with the good being inferior. Subsidizing a substitute good would decrease demand for the firm's own product.

Question 11

The cross-price elasticity of demand for printers with respect to the price of ink cartridges is -0.6. The price elasticity of demand for printers is -1.2. If the price of ink cartridges rises by 20%, what must happen to the price of printers for the quantity of printers sold to remain unchanged?

  1. The price of printers must decrease by 10%. (correct answer)
  2. The price of printers must decrease by 12%.
  3. The price of printers must increase by 10%.
  4. The price of printers must increase by 12%.
Explanation: This is a two-step problem. First, calculate the impact of the ink cartridge price increase on printer demand. The change in quantity demanded for printers is XED * (%ΔPrice_ink) = -0.6 * 20% = -12%. This means the demand for printers will fall by 12%. To keep the final quantity sold unchanged, the price of printers must change to generate an offsetting +12% change in quantity demanded. We use the price elasticity of demand for printers: PED = (%ΔQ_printers) / (%ΔP_printers). We need %ΔQ_printers to be +12%. So, -1.2 = +12% / (%ΔP_printers). Solving for %ΔP_printers gives +12% / -1.2 = -10%. The price of printers must decrease by 10%.

Question 12

The cross-price elasticity of demand between product A and product B is +1.5. The income elasticity of demand for product A is -0.5. A widespread economic recession leads to a 4% decrease in average consumer income. Simultaneously, due to a supply chain disruption, the price of product B increases by 6%. What is the expected net percentage change in the quantity demanded for product A?

  1. An increase of 7.0%
  2. An increase of 11.0% (correct answer)
  3. An increase of 2.0%
  4. A decrease of 7.0%
Explanation: This problem requires calculating two separate effects and summing them. First, the income effect: YED = -0.5 and %ΔIncome = -4%. The change in quantity demanded due to income is (-0.5) * (-4%) = +2.0%. Second, the cross-price effect: XED = +1.5 and %ΔPrice_B = +6%. The change in quantity demanded due to the price change of the substitute good is (+1.5) * (+6%) = +9.0%. The total net effect is the sum of these two effects: 2.0% + 9.0% = +11.0%.

Question 13

A city observes that when it raises the price of public bus fares, total revenue from the bus system increases. During the same period, they observe that revenue for the city's primary taxi service also increases. What can be concluded about the demand for these two services?

  1. Bus travel is a normal good, and taxi service is an inferior good.
  2. Bus travel and taxi service are substitutes, and the demand for bus travel is price-inelastic. (correct answer)
  3. Bus travel and taxi service are complements, and the demand for bus travel is price-elastic.
  4. Bus travel and taxi service are substitutes, and the demand for taxi service is price-inelastic.
Explanation: When the price of bus fares rises and total revenue increases, it indicates that the demand for bus travel is price-inelastic. The price increase for bus travel leads to an increase in revenue for the taxi service. This suggests that the demand curve for taxis has shifted to the right. A rightward shift in demand for one good when the price of another good rises means the two goods are substitutes. The information provided does not allow for a conclusion about the price elasticity of demand for taxi service or whether the goods are normal or inferior.

Question 14

A per-unit tax is imposed on a good. The burden of the tax will fall more heavily on producers than on consumers if which of the following is true?

  1. The price elasticity of demand is greater than the price elasticity of supply. (correct answer)
  2. The price elasticity of supply is greater than the price elasticity of demand.
  3. Both demand and supply are perfectly inelastic.
  4. Both demand and supply are highly elastic.
Explanation: The burden of a tax falls on the side of the market that is less elastic (more inelastic). For producers to bear a larger share of the tax burden, supply must be less elastic than demand. This is the same as saying the price elasticity of demand is greater than the price elasticity of supply. When supply is relatively inelastic, producers cannot easily reduce their quantity supplied in response to the lower effective price they receive, so they absorb more of the tax.

Question 15

A local bakery lowers the price of its cupcakes from $4.00 to $3.60. As a result, its weekly sales of coffee, priced at $3.00, increase from 500 cups to 530 cups. Using the midpoint method, the cross-price elasticity of demand for coffee with respect to the price of cupcakes is approximately:

  1. -0.55 (correct answer)
  2. +0.55
  3. -1.82
  4. +1.82
Explanation: The midpoint formula for cross-price elasticity is (ΔQA/avg QA)/(ΔPB/avg PB)(\Delta Q_A / \text{avg } Q_A) / (\Delta P_B / \text{avg } P_B). Here, A is coffee and B is cupcakes. ΔPcupcake=3.60−4.00=−0.40\Delta P_{cupcake} = 3.60 - 4.00 = -0.40. The average price is (4.00+3.60)/2=3.80(4.00+3.60)/2 = 3.80. So, %ΔPcupcake=−0.40/3.80≈−10.53%\%\Delta P_{cupcake} = -0.40 / 3.80 \approx -10.53\%. For coffee, ΔQcoffee=530−500=30\Delta Q_{coffee} = 530 - 500 = 30. The average quantity is (500+530)/2=515(500+530)/2 = 515. So, %ΔQcoffee=30/515≈+5.83%\%\Delta Q_{coffee} = 30 / 515 \approx +5.83\%. The cross-price elasticity is 5.83%/−10.53%≈−0.555.83\% / -10.53\% \approx -0.55. The negative sign indicates the goods are complements.

Question 16

A manufacturer of high-end electric bicycles (a luxury good) and a manufacturer of instant ramen noodles (an inferior good) are both reviewing economic forecasts. The forecasts agree that a significant recession is imminent. Which of the following correctly describes the likely change in the demand curve for each firm?

  1. Bicycles: shift right; Ramen: shift left.
  2. Bicycles: shift left; Ramen: shift right. (correct answer)
  3. Bicycles: shift right; Ramen: shift right.
  4. Bicycles: shift left; Ramen: shift left.
Explanation: A recession implies falling average incomes. For a luxury good (like high-end bicycles), income elasticity is positive and greater than 1. A decrease in income will cause a significant decrease in demand, shifting the demand curve to the left. For an inferior good (like instant ramen), income elasticity is negative. A decrease in income will cause an increase in demand, shifting the demand curve to the right.

Question 17

A report on the market for smartphones contains the following two statements:

  1. 'When average household income rose by 3%, the quantity of smartphones sold increased by 6%.'

  2. 'When the price of a major competitor's phone increased by 10%, the quantity of our smartphones sold increased by 15%.'

Based on the information in the passage, which of the following statements is correct?

  1. Smartphones are an inferior good with an income elasticity of +2.0.
  2. The two smartphone brands are complements, with a cross-price elasticity of +1.5.
  3. Smartphones are a luxury good, and the two brands are substitutes. (correct answer)
  4. Smartphones are a necessity good, and the two brands are complements.
Explanation: From statement 1, the income elasticity of demand is YED = (%ΔQ) / (%ΔI) = +6% / +3% = +2.0. Since YED > 1, smartphones are a luxury good (a type of normal good). From statement 2, the cross-price elasticity of demand is XED = (%ΔQ_our_phone) / (%ΔP_competitor) = +15% / +10% = +1.5. Since XED > 0, the two brands are substitutes. Therefore, smartphones are a luxury good and the brands are substitutes.

Question 18

Two firms, Alpha and Beta, sell the only two brands of a particular product. The cross-price elasticity of demand for Alpha's product with respect to Beta's price is +2.5. Alpha's marketing department is considering a 10% price reduction. What is the most direct and significant risk to Alpha's sales volume from this action?

  1. The cost of production will increase due to higher output.
  2. The demand for Alpha's product is likely price-inelastic, reducing total revenue.
  3. Consumers may perceive Alpha's product as being of lower quality.
  4. Beta may retaliate by also cutting its price, shifting demand away from Alpha. (correct answer)
Explanation: This question tests your understanding of oligopoly behavior and strategic interaction between firms, particularly how competitors respond to price changes when products are close substitutes. The cross-price elasticity of +2.5 tells you that Alpha's and Beta's products are substitutes — when Beta's price rises 1%, demand for Alpha's product increases 2.5%. This strong positive relationship means the firms are direct competitors, and each firm's pricing decisions significantly affect the other's sales. When Alpha cuts its price by 10%, it hopes to steal market share from Beta. However, the most significant risk is that Beta will retaliate with its own price cut. Since the products are close substitutes (evidenced by the high cross-price elasticity), Beta cannot afford to lose customers to Alpha's lower price. Beta's retaliatory price cut would shift demand back toward Beta's product, potentially leaving Alpha worse off than before — with lower prices but no net gain in market share. Looking at the wrong answers: (A) focuses on production costs rather than the strategic competitive response, which is the primary concern here. (B) misinterprets the situation — we're told about cross-price elasticity, not own-price elasticity, so we can't conclude Alpha's demand is inelastic. (C) addresses quality perception, but this is less immediate and significant than the direct competitive response from Beta. Study tip: In oligopoly questions, always consider how competitors will react to a firm's strategic moves. When you see high cross-price elasticities, expect fierce competitive responses to any pricing strategy.

Question 19

A government agency wants to forecast tax revenue from a new 10% sales tax on luxury yachts. The price elasticity of demand for yachts is estimated to be -2.5, and the price elasticity of supply is estimated to be +4.0. The new tax is likely to have which of the following effects?

  1. A large increase in the quantity of yachts sold, leading to higher-than-expected tax revenue.
  2. A large decrease in the equilibrium price of yachts received by producers.
  3. A large percentage decrease in the quantity of yachts sold, leading to lower-than-expected tax revenue. (correct answer)
  4. A large increase in the equilibrium price of yachts paid by consumers, with little change in quantity.
Explanation: When both demand and supply are highly elastic (magnitudes much greater than 1), the quantity traded is very responsive to price changes. Imposing a tax will create a wedge between the buyer's price and seller's price. Because both sides of the market are highly elastic, the primary response will be a significant reduction in the quantity of yachts bought and sold. This large drop in quantity will likely result in tax revenues that are much lower than a simple static calculation (10% of original revenue) would suggest.

Question 20

The price elasticity of supply for a product is 0.8. If a new technology lowers the marginal cost of production for all possible output levels, what will be the effect on the supply curve and the price elasticity of supply at any given price?

  1. The supply curve will shift right, and the elasticity of supply will become more elastic (increase). (correct answer)
  2. The supply curve will shift right, and the elasticity of supply will become more inelastic (decrease).
  3. The supply curve will shift left, and the elasticity of supply will become more elastic (increase).
  4. The supply curve will shift right, and the elasticity of supply will remain unchanged.
Explanation: A technology that lowers marginal cost makes production more profitable at any given price, shifting the supply curve to the right. Additionally, the new technology typically makes it easier and less costly for firms to increase output when prices rise, making supply more responsive to price changes. At any given price level, firms can now produce more quantity, and they can more readily adjust that quantity in response to price changes. This makes the price elasticity of supply more elastic (higher in absolute value).