2.03 Microeconomics

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Florida Gulf Coast University *

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2023

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Economics

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Feb 20, 2024

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pdf

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2.03 Price Elasticity of Demand (50 points total) To download this file, click: “ File ” - “ download as ” - Choose your file format, & Save to your Economics folder that you have created. Directions: Use ONE of the options below to complete the free-response question. Natalia Leroy February 1st, 2024 FRQ Option 1 Option 1: The following graph shows the market for widgets in a local hardware store. (a) Identify whether the price of widgets from $8 to $7 is elastic, unit elastic, or inelastic. Explain. By viewing the graph, this is elastic because as the price decreases, total revenue increases. P1= $8 Q1= 12 P2= $7 Q2= 16 P1 x Q1= 8 x 12 = 96 P2 x Q2= 7 x 16 = 112 At price $8, the revenue is 96. At price $7, the revenue is 112. This shows how by decreasing the price, the revenue increases.

(b) What is the price of widgets that maximizes the hardware store's revenue? Explain. The price of widgets that maximizes the hardware store’s revenue is $7. This is because at this price the total revenue is the highest, $112. When the price is $6, total revenue is $108. When the price is $8, total revenue is $96. $6 and $8 are closest prices above and below $7 in the table, and the total revenue for both values is less, $96 and $108, than the total revenue of $7, which is $112. (c) The price of widgets is $9. If the hardware store wants to increase its revenue, how should it change the price? Explain. When the price of widgets is $9 and the hardware store wants to increase its revenue, the demand will decrease as well as the price. This is because the demand is elastic, Since the demand is elastic, the hardware store should decrease the price in order to increase total revenue. As seen in letter (b), the price that maximizes revenue is $7; therefore selling widgets at $9 would not increase revenue. This price will make the demand move closer to being inelastic. This is because as price increases, the quantity demanded decreases. As prices increase in this case, the quantity demanded will be lower and the slope of the curve will look steeper, which means that the demand will get closer to being inelastic. (d) Using the midpoint formula, calculate the price elasticity of demand for widgets when price increases from $7 to $8. Identify the coefficient as elastic, unit elastic, or inelastic.

(e) Using the midpoint formula, calculate the price elasticity of demand for widgets when price decreases from $6 to $5. Identify the coefficient as elastic, unit elastic, or inelastic. (f) Based on the scenario in part (e), how does the decrease in price affect the hardware store's revenue? Based on the scenario in part (e):

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At P = $6, quantity demanded is 18, so the total revenue is $108 At P = $5, quantity demanded is 20, so the total revenue is $100 When the price decreases from $6 to $5, the total revenue falls from $108 to $100. The hardware store should not decrease the price from $6 to $5 because their revenue will decrease instead of increase. In this case, a decrease in price results in a decrease in total revenue as well. The lower the price, the higher the quantity demanded will be. At $6, quantity demanded is 18, and at $5 quantity demanded is 20. As the price goes down, the quantity demanded goes up, which makes the demand closer to being elastic. As it is seen in the graph, the slope will keep constantly declining.

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