Chapter 5

• What event could drive up the price of gasoline in the United States?


  A war in the Middle East, a booming Chinese economy, or a new tax on gasoline
• How would U.S. consumers typically respond to a higher price of gasoline?


  They would buy less gas
• What does the law of demand state?


  When the price of a good rises, the quantity demanded falls
• What concept is used to determine how much gas purchases would fall due to price increases?

  Elasticity
• What is elasticity in economics?


  • A measure of how much buyers and sellers respond to changes in market conditions
  • Discusses both the direction and magnitude of effects
  • Useful in various applications
• How does the quantity demanded of gasoline respond in the long run compared to the short run?


  It responds more in the long run than in the short run
• What is the approximate reduction in gasoline consumption after a 10 percent increase in prices after one year?


  About 2.5 percent
• What is the approximate reduction in gasoline consumption after a 10 percent increase in prices after five years?


  About 6 percent
• What are the two main responses that lead to the long-run reduction in gasoline consumption?


  People drive less and switch to more fuel-efficient cars
• What factors influence the price elasticity of demand?


  • Availability of close substitutes
  • Necessities versus luxuries
  • Definition of the market
  • Time horizon
• What does it mean if demand for a good is elastic?


  The quantity demanded responds substantially to changes in price
• What does it mean if demand for a good is inelastic?


  The quantity demanded responds only slightly to changes in price
• How does the availability of close substitutes affect demand elasticity?


  More elastic demand because consumers can easily switch to substitutes
• How do necessities and luxuries differ in terms of demand elasticity?


  Necessities tend to have inelastic demands, while luxuries have elastic demands
• How does the definition of the market affect demand elasticity?


  Narrowly defined markets tend to have more elastic demand than broadly defined markets
• How does the time horizon affect demand elasticity?


  Goods tend to have more elastic demand over longer time horizons
• How is the price elasticity of demand computed?


  As the percentage change in quantity demanded divided by the percentage change in price
• If a 10 percent increase in the price of an ice-cream cone causes a 20 percent fall in quantity demanded, what is the price elasticity of demand?


  2
• Why are price elasticities of demand sometimes reported as negative numbers?


  Because the quantity demanded is negatively related to price
• What does a larger price elasticity imply?


  A greater responsiveness of quantity demanded to changes in price
• What is the midpoint method in calculating price elasticity of demand?


  • A method to avoid discrepancies in elasticity calculations between two points
  • Computes percentage change using the midpoint (average) of initial and final levels
  • Provides consistent results regardless of direction of change
• What is the formula for the midpoint method for calculating price elasticity of demand?


  Price elasticity of demand = (Percentage change in quantity) / (Percentage change in price)
• How do economists classify demand curves based on elasticity?


  Elastic if elasticity > 1, inelastic if elasticity < 1, unit elasticity if elasticity = 1
• What does a perfectly inelastic demand curve look like?


  It is vertical, indicating quantity demanded stays the same regardless of price
• What does a perfectly elastic demand curve look like?


  It is horizontal, indicating very small changes in price lead to huge changes in quantity demanded
• What are the limitations of estimating price elasticities of demand?


  • Statistical techniques require assumptions that may not hold true
  • Price elasticity may vary at different points on a demand curve
  • Different studies may report different elasticities for the same good
• What is the significance of collecting data on price elasticities of demand?


  • Helps economists understand how price changes influence quantity demanded
  • Provides specific numbers for elasticity estimates
  • Aids in market analysis and policy-making
• Why might different studies report different price elasticities of demand for the same good?


  Because the techniques used to obtain them require assumptions that might not be true in practice.
• What is the price elasticity of demand for eggs?


  0.1
• What is the price elasticity of demand for healthcare?


  0.2
• What is the price elasticity of demand for cigarettes?


  0.4
• What is the price elasticity of demand for rice?


  0.5
• What is the price elasticity of demand for housing?


  0.7
• What is the price elasticity of demand for beef?


  1. 6
• What is the price elasticity of demand for peanut butter?


  1. 7
• What is the price elasticity of demand for restaurant meals?


  1. 3
• What is the price elasticity of demand for Cheerios?


  1. 7