1215

Marko Tskitishvili, an economist, has been studying the drop in the price of the average household computer in the U.S. and wonders if computers should still be considered a luxury good or if it has now become a normal good. He conducts a survey of 500 people and finds the following:

	1998	2005
Avg. Household Income	$41,000	$53,000
Avg. Computers Purchased per Household	0.42	0.57

*Assume that 1998 is the base rate.

Based on the above data, Tskitishvili would conclude that a computer is a:

A) luxury good with income elasticity of 1.18.

B) luxury good with income elasticity of 1.01.

C) normal good with income elasticity of 0.84.

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% change in computers demanded = ( 0.57- 0.42) / 0.495 = 30.30%
% change in income = ($53,000 - $41,000) / $47,000 = 25.53%
30.30% / 25.53% = 1.18

1.18 > 1 so Tskitishvili would conclude that computers are a luxury good.

1215

If quantity demanded declines 20% when incomes fall 3%, this good is:

A) a necessity.

B) an inferior good.

C) a luxury good.

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Income elasticity is the sensitivity of demand to changes in consumer income. Income elasticity for this good = (percent change in quantity demanded) / (percent change in income) = -20 / -3 = 6.7. Normal goods with high income elasticities (absolute values > 1) are considered luxury goods, a type of normal good that experiences a greater percentage increase in demand than the percentage increase in income.

1215

Income elasticity is defined as the:

A) change in quantity demanded divided by the change in income.

B) percentage change in the quantity demanded divided by the percentage change in income.

C) percentage change in income divided by the percentage change in the quantity demanded.

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Income elasticity is defined as the percentage change in quantity demanded divided by the percentage change in income. Normal goods have positive values for income elasticity and inferior goods have negative income elasticities.

1215

When household incomes go down and the quantity of a product demanded goes up, the product is:

A) an inferior good.

B) a necessity.

C) a normal good.

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When household incomes go down and the quantity demanded of a product goes up, the product is an inferior good. Inferior goods include things like bus travel and margarine.

1215

If the price elasticity of demand is -1.5 and you increase the price of the product 2%, the quantity demanded will (closest to):

A) decrease 3%.

B) decrease 1.5%.

C) decrease 0.75%.

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If the price elasticity of demand is -1.5, and you increase the price of the product 2%, the quantity demanded will decrease approximately 3%. When the price elasticity is negative, it means that price and demand move in opposite directions. Given a price decrease, demand will increase and vice versa. The absolute value, 1.5, indicates that demand will move one-and-a-half times as much as price.

1215

If the price of a candy bar increases from $0.50 to $0.55 and the quantity demanded decreases from 267 to 235, the price elasticity of demand is:

A) -1.34.

B) 1.34.

C) -1.23.

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Price elasticity of demand is calculated by dividing the percent change in quantity demanded by the percent change in price, using the average value of the variable in the computations. The percent change in quantity demanded is (235 ? 267) / [(235 + 267) / 2] = -32 / 251 = -0.127 or -12.7%. The percent change in price is = (0.55 ? 0.50) / [(0.55 + 0.50) / 2] = 0.05 / 0.525 = 0.095 or 9.5%. The price elasticity of demand is -12.7 / 9.5 = -1.34.

1215

If the price elasticity of demand is 1.5 and a change in the price of the product increases the quantity demanded by 4%, then what is the percent change in price?

A) +2.667%.

B) ?2.667%.

C) –0.375%.

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Price elasticity of demand is calculated by dividing the percent change in quantity demanded by the percent change in price. The percent change in price is, therefore, the percent change in quantity demanded divided by the price elasticity of demand = 4 / 1.5 = 2.667.

Because of the inverse relationship between quantity demanded and price, the price elasticity is always going to be negative although economists usually ignore the negative sign and just use the absolute value. To properly predict the price change a negative sign needs to be added to the price elasticity before the calculation or to the answer after the calculation.

Using the latter case, the 2.667% will become -2.667%, showing that an increase in quantity demanded of 4% will cause a decrease in the price of 2.667% when the price elasticity is 1.5 (-1.5).

1215

If the price elasticity of demand for a good is 4.0, then a 10% increase in price would result in a:

A) 4% decrease in the quantity demanded.

B) 40% decrease in the quantity demanded.

C) 10% decrease in the quantity demanded.

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Price elasticity of demand = (% change in Q demanded / % change in price). Given the price elasticity of demand and the percentage change in price, we can solve for the percentage change in Q demanded.

1215

The price of product Z decreased from $2.50 per unit to $2.00 per unit.  Since the price decreased, demand has gone up from 3 million units to 4 million units.  Calculate the respective price elasticity of demand and determine the elasticity of demand.

A) ?1.29; elastic.

B) ?1.29; inelastic.

C) ?2.00; elastic.

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percentage change in quantity = [(4 ? 3)] / [(4 + 3) / 2] = 1 / 3.5 = 0.286 = 28.6%

percentage change in price = [(2 ? 2.5)] / [(2 + 2.5) / 2] = -0.5 / 2.25 = -0.222 = -22.2%

28.6 % / -22.2% = -1.29

Since the price elasticity of demand is greater than 1 (ignore the sign), product Z is elastic

1215

If the number of widgets demanded changes from 51 to 49 when the price changes from $4 to $6, the price elasticity of demand is:

A) Elastic.

B) -2.00.

C) -0.10.

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Price elasticity of demand is calculated by dividing the percent change in quantity demanded by the percent change in price, using the average value of the variable in the computations. The percent change in quantity demanded is (51 – 49) / ((51 + 49) / 2) = 0.04. The percent change in price is (4 – 6) / (4 + 6) / 2 = -0.40. The price elasticity of demand is 0.04 / -0.4 = -0.10.