ELASTICITY We can gain insight by manipulating the price elasticity of demand eq

Question

ELASTICITY

We can gain insight by manipulating the price elasticity of demand equation. With the information provided below, demonstrate what happens in the specific markets.

a) Suppose there is a technological change that allows manufacturers to make Android smartphones much more cheaply. In fact, the retail price falls by 15%, ceteris paribus.

i) If the price elasticity of demand is -0.8, how much does the quantity demanded change?

ii) Statement: the producers are definitely better off. True, false, uncertain, or not enough information? Explain why? (Hint: recall elasticity-total revenue table in lecture. Simple way is to construct a numerical example…i.e., where the initial price is $100, while initial quantity is 100 units. )

b) In an alternative scenario, ceteris paribus, suppose there is a new tax on data usage. The cum-tax monthly bill increases by 10%.

i) If the price elasticity of demand is -0.45, how much does the quantity demanded change?

ii) Statement: the data plan providers are definitely worse off. True, false, uncertain, or not enough information? Explain why? (Hint: recall elasticity-total revenue table in lecture. Simple way is to construct a numerical example…i.e., where the initial price is $100, while initial quantity is 100 units. )

Explanation / Answer

a

.i. Price elasticity of demand = Percentage change in quantity demand / Percentage change in Price

-0.8 = Percentage Change in quantity demanded / -15

Percentage increase in quantity demanded = 12 per cent (-.8 * 15)

ii. False. This is based on the price elasticity of demand and total revenue relationship. When the price of the good falls and price elasticity of demand is inelastic, the total revenue of the firm will fall. Thus, the producers will be worse off.

b. i. Percentage change in quantity demanded = -0.45 * 10 = 4.5 per cent.

ii. False. This is also based on the Total revenue and price elasticity of demand relationship. When the price of the good rises and price elasticity of demand is inelastic, there will be increase in total revenue of the producers. In this case, Total revenue of the data providers will rise. Thus, they will be better off. The quantity demanded is falling by a less amount than the rise in the prices.

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