1. Explain the meaning of elasticity? What are the different types of elasticiti
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Question
1. Explain the meaning of elasticity? What are the different types of elasticities? Of what use are these elasticities to business ( in other words to Total Revenue) ? (3 marks)
2. A firm supplied 3000 pens at the rate of AED 10 per pen. Next month, due to a rise in the price to AED 22 per pen, the supply of the firm increased to 5000 pens. Using the midpoint method find the price elasticity of supply of pens. (3 marks)
3. The government of Dubai had been concerned about the recent explosion in apartment rental rates for low income families. To combat this problem, a proposal has been made to institute rent control that would place $850 per month ceiling on apartment rental rates. Apartment supply and demand in the market are expressed in the following equations:
Qs = - 400 + 2P Market Supply
Qd= 5,600 – 4P Market Demand
Where Q is the number of apartments and P is the rental rate
A. Calculate the equilibrium rental rate and the equilibrium apartments rented (3 marks)
B. Determine the quantity demanded, quantity supplied, and shortage with a $ 850 per month ceiling price on apartment rental rates (3 marks)
C. Determine the amount of consumer and producer surplus with rent control (3 marks)
Explanation / Answer
Ans 1 – Elasticity is the relative change in the one factor with regards to a change in some other factor. It gives the effect of one factor on the other. There are different types of elasticity namely, Price elasticity, Income elasticity and Cross Elasticity. Any business can have its own elasticity if it wants to compare one thing with other. Elasticities give out the picture of the overall effect/change in the total revenue with a change in one of the factors. For example, price elasticity estimates the change in demand or supply of the product thus giving out the total revenue earned by changing the price.
Ans 2 – Midpoint approach to calculate the price elasticity of supply = Change in quantity supplied / Average quantity / Change in price / Average price.
Price elasticity of supply = (5000 – 3000) / ((5000 + 3000)/2) / (22 – 10) / ((22 + 10) / 2)
= (2000 / 4000) / (12 / 16) = 0.5 / 0.75 = 0.667
Ans 3 A – At equilibrium, Demand = Supply. Hence, -400 + 2P = 5600 – 4P.
6P = 6000. P + 1000. Equilibrium rental rate is $1000.
Equilibrium apartments rented = 5600 – 4000 = 1600 apartments
Ans 3 B – When price is $850, the quantity demanded = 5600 – 4 x 850 = 2200 apartments. Quantity supplied = -400 + 2P = 1300 apartments. Shortage = quantity demanded – quantity supplied = 900.
Ans 3 C – Price at which there is no supply = $200 & Price at which quantity demanded is 1300 = $1075.
Price at which there is no demand = $1400. The total surplus with a price ceiling forms a trapezium with these areas and the quantity supplied as the height. One base of the trapezium is the price at which there is no supply – price at which there is no demand = 1400 – 200 = 1200. The other base of the trapezium is the price at which demand is 1300 – price ceiling = 1075 – 850 = 225. The area of trapezium is Average base x height = (1200 + 225) / 2 x 1300 = $926250. The producer surplus is a triangle formed with the height as the quantity supplied at price ceiling and base as the difference between the price where there is no supply and the price ceiling. Area of triangle = height x base / 2 = 1300 x 650 / 2 = $422500. The consumer surplus is the remainder of the total surplus = 926250 – 422500 = $503750.
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