5.1 CHAPTER REVIEW

FACTS AND TOOLS

Question 5.6

1. For each of the following pairs, which of the two goods is more likely to be inelastically demanded and why? Table 5.1 should help:

  1. Demand for tangerines vs. demand for fruit

  2. Demand for beef next month vs. demand for beef over the next decade

  3. Demand for Exxon gasoline at the corner of 7th and Grand vs. demand for gasoline in the entire city

  4. Demand for insulin vs. demand for vitamins

Question 5.7

2. For each of the following pairs, which of the two goods is more likely to be elastically supplied? Table 5.3 should help:

  1. Supply of apples over the next growing season vs. supply of apples over the next decade

  2. Supply of construction workers in Binghamton, New York, vs. supply of construction workers in New York State

  3. Supply of breakfast cereal vs. supply of food

  4. Supply of gold vs. supply of computers

Question 5.8

3. Indicate whether the demand for the good would become more elastic or less elastic after each of the following changes. (Note that in each of these cases, the demand curve may also shift inward or outward, but in this question we are interested in whether the demand becomes more or less elastic.) Briefly justify your answer.

  1. The demand curve for soap after wide understanding that bacteria and other organisms cause and spread disease

  2. The demand curve for coal after the invention of nuclear power plants

  3. The demand curve for cars as more employers allow employees to telecommute

  4. The demand curve for a new television during an economic boom

Question 5.9

4. For each of the following, indicate if the supply for the good would become more elastic or less elastic as a result of each change, and briefly justify your answer. (Once again, in each case the supply curve will also shift, but we are interested in changes in the elasticity.)

  1. The supply curve for diamonds if a new process for manufacturing diamonds is created

  2. The supply curve for food if pesticides and fertilizers were banned

  3. The supply curve for plastic if a very large share of oil output was used to make plastic

  4. The supply curve for nurses after several years of increasing wages in nursing

Question 5.10

5. Let’s work out a few examples to get a sense of what elasticity of demand means in practice. Remember that in all of these cases, we’re moving along a fixed demand curve—so think of supply increasing or decreasing, while the demand curve is staying in the same place.

  1. If the elasticity of demand for college textbooks is −0.1 and the price of textbooks increases by 20%, how much will the quantity demanded change, and in what direction?

  2. In your answer to part a, was your answer in percentages or in total number of textbooks?

  3. If the elasticity of demand for spring break packages to Cancun is −5, and if you notice that this year in Cancun the quantity of packages demanded increased by 10%, then what happened to the price of Cancun vacation packages?

    87

  4. In your college town, real estate developers are building thousands of new student-friendly apartments close to campus. If you want to pay the lowest rent possible, should you hope that demand for apartments is elastic or inelastic?

  5. In your college town, the local government decrees that thousands of apartments close to campus are uninhabitable and must be torn down next semester. If you want to pay the lowest rent possible, should you hope that demand for apartments is elastic or inelastic?

  6. If the elasticity of demand for ballpoint pens with blue ink is −20, and the price of ballpoint pens with blue ink rises by 1%, what happens to the quantity demanded?

  7. What’s an obvious substitute for ballpoint pens with blue ink? (This obvious substitute explains why the demand is so elastic.)

Question 5.11

6. It’s an important tradition in the Santos family that they eat the same meal at their favorite restaurant every Sunday. By contrast, the Chen family spends exactly $50 for their Sunday meal at whatever restaurant sounds best.

  1. Which family has a more elastic demand for restaurant food?

  2. Which family has a unit elastic demand for restaurant food? (Hint: How would each family respond to an increase in food prices?)

Question 5.12

7. The U.S. Department of Agriculture (USDA) has been concerned that Americans aren’t eating enough fruits and vegetables, and they’ve considered coupons and other subsidies to encourage people—especially lower-income people—to eat these healthier foods. Of course, if people’s demand for fruits and vegetables is perfectly inelastic, then there’s no point in giving out coupons (thought question: why?). If instead the demand is only somewhat elastic, there may be better ways to spend taxpayer dollars.

This is clearly a situation where you’d want to know the elasticity of fruit and vegetable demand: If people respond a lot to small changes in price, then government-funded fruit and vegetable coupons could make poorer Americans a lot healthier, which might save taxpayers money if they don’t have to pay for expensive medical treatments for unhealthy eaters. There are a lot of links in this chain of reasoning—all of which are covered in more advanced economics courses—but the first link is whether people actually have elastic demand for fruits and vegetables. The USDA’s Economic Research Service employs economists to answer these sorts of questions, and a recent report contained the following estimated elasticities (Source: Diansheng Dong and Biing-Hwan Lin. 2009. Fruit and vegetable consumption by low-income Americans: Would a price reduction make a difference? Economic Research Report 70, USDA).

Fruit

Elasticity of Demand

Apple

−0.16

Banana

−0.42

Grapefruit

−1.02

Grapes

−0.91

Orange

−1.14

  1. Based on these demand elasticity estimates, which fruit is most inelastically demanded? Which is most elastically demanded?

  2. For which of these fruits would a 10% drop in price cause an increase in total revenue from the sale of that fruit?

  3. If the government could offer “10% off” coupons for only three of these fruits, and it wanted to have the biggest possible effect on quantity demanded, which three fruits should get the coupons?

  4. Overall, the authors found that for the average fruit, the elasticity of demand was about −0.5. Is the demand for fruit elastic or inelastic?

Question 5.13

8. On average, old cars pollute more than newer cars. Therefore, every few years, a politician proposes a cash for clunkers program: The government offers to buy up and destroy old, high-polluting cars. If a cash for clunkers program buys 1,000 old, high-polluting cars, is this the same as saying that there are 1,000 fewer old, high-polluting cars on the road? Why or why not?

88

Question 5.14

9. As we noted in the chapter, many economists have estimated the short-run and long-run elasticities of oil demand. Let’s see if a rise in the price of oil hurts oil revenues in the long run. Cooper, the author cited in this chapter, found that in the United States, the long-run elasticity of oil demand is −0.5.

  1. If the price of oil rises by 10%, how much will the quantity of oil demanded fall: by 5%, by 0.5%, by 2%, or by 20%?

  2. Does a 10% rise in oil prices increase or decrease total revenues to the oil producers?

  3. Some policymakers and environmental scientists would like to see the United States cut back on its use of oil in the long run. We can use this elasticity estimate to get a rough measure of how high the price of oil would have to permanently rise in order to get people to make big cuts in oil consumption. How much would the price of oil have to permanently rise in order to cut oil consumption by 50%?

  4. France has the largest long-run elasticity of oil demand (−0.6) of any of the large, rich countries, according to Cooper’s estimates. Does this mean that France is better at responding to long-run price changes than other rich countries, or does it mean France is worse at responding?

Question 5.15

10. Figure 5.3 and Table 5.2 both set out some important but tedious rules. Let’s practice them, since they are quite likely to be on an exam. For each of the following cases, state whether the demand curve is relatively steep or flat and whether a fall in price will raise total revenue or lower it. In this case, note that we present the elasticity in terms of its absolute value.

  1. Elasticity of demand = 0.2

  2. Elasticity of demand = 2.0

  3. Elasticity of demand = 10.0

  4. Elasticity of demand = 1.1

  5. Elasticity of demand = 0.9

Question 5.16

11. A lot of American action movies are quests to eliminate a villain. If in real life, villains are elastically supplied (like guns for buyback programs), should we care whether the hero captures a particular villain? Why or why not?

THINKING AND PROBLEM SOLVING

Question 5.17

1. During the Middle Ages, the African city of Taghaza quarried salt in 200-pound blocks to be sent to the salt market in Timbuktu, in present-day Mali. Travelers report that Taghazans used salt instead of wood to construct buildings.

Compared with other towns without big salt mines, was the demand for wood more elastic or less elastic in Taghaza? How do you know?

Question 5.18

2. Suppose that drug addicts pay for their addiction by stealing: So the higher the total revenue of the illegal drug industry, the higher the amount of theft. If a government crackdown on drug suppliers leads to a higher price of drugs, what will happen to the amount of stealing if the demand for drugs is elastic? What if the demand for drugs is inelastic?

Question 5.19

3. Henry Ford famously mass-produced cars at the beginning of the twentieth century, starting Ford Motor Company. He made millions because mass production made cars cheap to make, and he passed some of the savings to the consumer in the form of a low price. Cars became a common sight in the United States thereafter. Keeping total revenue and its relationship with price in mind, do you expect the demand for cars to be elastic or inelastic given the story of Henry Ford?

Question 5.20

4. In Chapter 10, you’ll see that we purchased permits to pollute the air with sulfur dioxide (SO2). We didn’t use the permits: Instead, we threw them out. In other words, we bought permits for the same reason the government buys guns in gun buyback programs—to prevent what we bought from being used. As we discussed in the chapter, gun buyback programs have failed. So why is our plan to buy permits more likely to get SO2 out of the air than the government’s plan to get guns off the street?

89

Question 5.21

5. How might elasticities help to explain why people on vacation tend to spend more for food and necessities than the local population?

Question 5.22

6. In the short run, the price elasticity of the demand and supply of electricity can be very low.

  1. How might revenue for the electricity industry change if one power plant were shut down for maintenance, reducing supply?

  2. If one power company owned many power plants, would it have a short-term incentive to keep all of its plants running, or could it have a short-term incentive to shut down a power plant now and then?

Question 5.23

7. Immigration is a fact of life in the United States. This will lead to a big boost in the labor supply. What field would you rather be in: a field where the demand for your kind of labor is elastic or a field where the demand for your kind of labor is inelastic?

Question 5.24

8. In the world of fashion, the power to imitate a trendy look is the power to make money. Stores such as H&M and Forever 21 focus on imitating fashions wherever possible: As soon as they see that a new look is coming along, something people are willing to pay a high price for, they start cranking out that look. Do these imitation-centered stores make the supply of clothing more elastic or less elastic? How can you tell?

Question 5.25

9. The relationship between elasticity of demand and total revenue can be a helpful shortcut, particularly if your professor likes to give multiple-choice exams. For each of the following examples, calculate how much money each consumer spends at the low price and at the high price, and decide whether the right answer for a question asking for the price elasticity of demand on a multiple-choice exam would be (a) −2.33, (b) −1.17, (c) −1.00, or (d) −0.56. Remember, if the consumer spends more money at the lower price, demand must be elastic. (Warning: Two of these will require a bit of guesstimation.)

  1. When the price of a movie ticket rises from $6 to $8 for senior citizens, Gary (a senior citizen) decides to go to the movies every other day (15 times per month) instead of every day (30 times per month).

  2. When the price of a large specialty coffee drink rises from $3 to $4, Martha reduces her weekly consumption from 7 to 5.

  3. When PX = $10.00, . When PX = $7.50, .

Question 5.26

10. Let’s practice the midpoint formula. Calculate the elasticity of demand for each of the following goods or services.

Good or Service

Beginning Price

Beginning Quantity

Ending Price

Ending Quantity

Elasticity

Daily movie ticket sales in Denver, Colorado

$6

50,000

$10

40,000

 

Weekly milk sales at Loma Vista Elementary School

$1

  1,000

$1.50

     800

 

Weekly round-trip ticket sales, New York to San Francisco

$500

10,000

$1,000

  9,000

 

Annual student enrollments, Upper Tennessee State University

$6,000

40,000

$9,000

39,000

90

CHALLENGES

Question 5.27

1. In this chapter, we’ve emphasized that the elasticity of supply is higher in the long run than in the short run. In a lot of cases, this is surely true: If you see that jobs pay more in the next state over, you won’t move there the next week but you might move there next year. But sometimes the short-run elasticity will be higher than the long-run elasticity.

Austan Goolsbee found an interesting example of this when he looked at the elasticity of income of highly paid executives with respect to taxes. In 1993, then President Clinton passed a law raising income taxes. This tax hike was fully expected: He campaigned on it in 1992.

  1. What do you expect happened to executive income in the first year of the tax increases? What about in subsequent years? (Source: Goolsbee, Austan. 2000. What happens when you tax the rich? Evidence from executive compensation. Journal of Political Economy 108(2): 352–378. For a book on the topic written by a leading economist, see Joel Slemrod, ed. 2000. Does Atlas Shrug? [Cambridge, MA: Harvard University Press].)

    (Hint: Top executives have a lot of power over when they get paid for their work: They can ask for bonuses a bit earlier, or they can cash out their stock options a bit earlier. Literally, this isn’t their “labor supply”; it’s more like their “income supply.”)

  2. Goolsbee estimated that the short-run elasticity of “income supply” for these executives was 1.4, while the long-run elasticity of “income supply” was 0.1. (Note: Goolsbee used a variety of statistical methods to look for these elasticities, and all came to roughly the same result.) If taxes pushed down their take-home income by 10%, how much would this cut the amount of income supplied in the short run? In the long run?

  3. You are a newspaper reporter. Your editor tells you to write a short story with this title: “Goolsbee’s research proves that tax hikes make the rich work less.” Make your case in one sentence.

  4. You are a newspaper reporter. Your editor tells you to write a short story with this title: “Goolsbee’s research proves that tax hikes have little effect on work by the wealthy.” Make your case in one sentence.

  5. Which story is more truthful?

Question 5.28

2. We saw that a gun buyback program was unlikely to work in Washington, D.C. If the entire United States ran a gun buyback program, would that be better at eliminating guns or worse? Why? What about if the gun buyback was also accompanied by a law making (at least some) guns illegal?

Question 5.29

3. Using the data from the ANWR example, what will be the percentage increase in quantity supplied if ANWR raises supply by 1%? No, this isn’t a trick question, and the formula is already there in the chapter. Why isn’t this number just 1%?

!launch! WORK IT OUT

Figure 5.3 and Table 5.2 both set out some important but tedious rules. Let’s practice them, since they are quite likely to be on an exam. For each of the following cases, state whether the demand curve is relatively steep or flat and whether a fall in price will raise total revenue or lower it. In this case, note that we present the elasticity in terms of its absolute value.

  1. Elasticity of demand = 0.7

  2. Elasticity of demand = 3.0

  3. Elasticity of demand = 20.0

  4. Elasticity of demand = 1.05

  5. Elasticity of demand = 0.95

91