ABBE 1013 MICROECONOMICSTUTORIAL 4

Section A: Multiple-Choice Questions

1. The price elasticity of demand is the ratio of the________________________

A. absolute change in quantity demanded to the absolute change in.B. absolute change in price to the absolute change in quantity demanded.C. percentage change in quantity demanded to the percentage change in price.D. percentage change in price to the percentage change in quantity demand.

2. If quantity demanded rises by 75 percent as price falls by 20 percent, the coefficient of price elasticity of demand equals _______________.

A. 0.26B. 2.25C. 3.5D. 3.75

3. If Ahmad’s salary went up from RM1,200 to RM1,500, while his monthly demand for cigarettes increased from 10 packets to 12 packets, then Ahmad’s income elasticity of demand for cigarettes is considered to be _______________________.

A. elasticB. inelasticC. unit elasticD. indeterminate

4. If total revenue decreases when price increases, the price elasticity of demand is __________.

A. perfectly inelasticB. elasticC. inelastic D. unit elastic

5. If demand is perfectly inelastic, it follows that a _______________________________.

A. fall in price will change quantity demanded by more than a rise in priceB. fall in price will not change quantity demandedC. rise in price will change quantity demanded by more than a fall in priceD. none of the above

6. If total revenue does not change as a result of a rise in price, it follows that demand is ____________.

A. InelasticB. perfectly inelasticC. unit elasticD. perfectly elastic

7. Price falls from RM1.50 to RM1.20, and the quantity demanded rises from 80 units to 90 units. What is the coefficient of price elasticity of demand between the two prices?

A. 0.53B. 0.75C. 1.89D. 1.57

8. Which of the following is NOT a determinant of price elasticity of demand?

A. the amount of time that has passed since a price changeB. the percentage of one's budget spent on the goodC. the number of substitutesD. the total income of household

9. If a small increase in the price of a good reduces quantity demanded to zero, demand is _______________ and the elasticity coefficient is _______________.A. perfectly elastic; equal to zeroB. unit elastic; equal to oneC. perfectly elastic; equal to infinityD. perfectly inelastic; equal to zero

10. Refer to diagram 1, the demand curve D3 is____________.

A. elasticB. perfectly elasticC. inelasticD. unit elastic

11. Refer to diagram 1, the demand curve D2 is____________.

A. inelasticB. perfectly elasticC. unit elasticD. perfectly inelastic

12. Refer to diagram 1, the demand curve D4 is____________.A. elasticB. perfectly elasticC. inelasticD. perfectly inelastic

6-4

Price

Quantity Demanded

D3

D1

D2

D4

Diagram 1

SECTION B: ESSAY QUESTIONS

1. Explain the price elasticity of demand. (3 marks)

A measure of the responsiveness of quantity demanded to changes in price.- It addresses the “percentage change in quantity demanded for a given percentage change in price”. - Measured by dividing the percentage change in the quantity demanded of a good by the percentage change in its price.- i.e. The price of computer raise by 10%, as a result, the quantity demanded for the computer falls by 20%.

[Source: April examination, 2010/2011, Q3(c)(i)]

2. Describe the relationship between price elasticity of demand and total revenue. (9 marks)[Source: April/May examination, 2007/2008, Q3(c)]

If demand is elastic (%Qd > %P),

- a price rise decreases total revenue.

- E.g. if P rises by 5%, Qd falls by 8% TR falls.

- a price fall increases total revenue.- E.g. if P falls by 1%, Qd rises by 6% TR risesIf demand is inelastic (%Qd < %P),

- a price fall decreases total revenue.

- E.g.if P falls by 5%, Qd rises by 2% TR falls.If demand is unit elastic (%Qd = %P),

- more goods sold with a price fall while total revenue remains constant.

- E.g. if P falls by 5%, Qd rises by 5% TR remains constant.

3. Using the midpoint formula, calculate the price elasticity of demand if the price decreases from RM6 to RM4 and quantity increases from 80 units to 90 units. (3 marks)

[Source: Aug/Sept examination, 2010/2011, Q3 (d) (i)]6-4=2 90-80= 102/6=0.3333…. -10/80= -0.125

-0.125/0.33333…= -0.375Price elasticity of demand = 0.38When the price increase 1%, the quantity of demand will decease 0.38%

4. Suppose a seller increases the price of cakes from RM10 to RM12. This causes the quantity demanded to fall from 580 units to 500 units.

i. Using the midpoint approach, calculate the price elasticity of demand for cakes. (3 marks)12-10=2 580-500=802/10=0.2 -80/500= - 0.16

-0.16/0.2= 0.8When the price increase 1%, the quantity of demand will decease 1.8%

If the seller’s objective is to increase total revenue, should he increase the price? Why? (2 marks)

Total revenue original = 10*580= 5800New total revenue = 12*500=6000The seller should increase the price because It will cause the total revenue increase.From 5800 o 6000

[Source: Jan/Feb examination, 2009/2010, Q3(d)]

5. In June 2010, a local fashion magazine reduced its price per copy from RM1.20 to RM1.00. As a result, the number of magazines sold increased from 240,000 to 300,000 copies.

(i) Calculate the magazine’s price elasticity of demand and interpret the answer. (6 marks)1.2-1=0.2 300 000-240 000 = 60 0000.2/1.2=0.1666667 60 000/240 000 = 0.25

0.25/ 0.167= 1.5When the price increase 1 %, the quantity of demand will decrease 1.5%

(ii) Based on the answer above, do you think the decision to reduce the price of the magazine is correct? (2 marks)

Original total revenue = 1.2*240 000= 288 000New total revenue = 1*300 000 = 300 000The magazine price should reduce because the total revenue will increase form 288 000 to 300 000

[Source: Jan examination, 2010/2011, Q3 (d)(i) & (ii)]