Define the price elasticity of demand and provide the formula for calculating the price elasticity of demand using the midpoint method.
Refer to the table provided. Using the midpoint method, calculate the price elasticity of demand for good X.
Based on your calculation of the price elasticity of demand in part b, if the price increases by 10%, in what direction and by what percentage will the quantity demanded change?
| Price | Good X Quantity demanded |
| $2 | 800 |
| $4 | 500 |
1 point: The price elasticity of demand measures the responsiveness of the quantity demanded to price changes.
1 point: (Change in quantity demanded/average quantity demanded)/(change in price/average price)
1 point: 0.69
1 point: Decrease
1 point: 6.9%
Assume the price of an inferior good increases.
In what direction will the substitution effect change the quantity demanded? Explain.
In what direction will the income effect change the quantity demanded? Explain.
Given that the demand curve for the good slopes downward, what is true of the relative sizes of the income and substitution effects for the inferior good? Explain. (6 points)
Rubric for FRQ 2 (6 points)
1 point: The substitution effect will decrease the quantity demanded.
1 point: As the price increases, consumers will buy other goods instead.
1 point: The income effect will increase the quantity demanded.
1 point: As the price increases, real income decreases, so consumers will purchase more of the inferior good.
1 point: The substitution effect is larger than the income effect.
1 point: If the income effect were larger than the substitution effect, more of the good would be purchased as the price increased, and the demand curve would be upward-sloping.