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Additional Topics in Demand Theory
Substitute In the case of a substitute, the change in the demand for a good or service is positively related to a change in the price of a related good or service, and the cross-price elasticity of demand is positive. Total revenue The price of a product multiplied by the quantity sold (i.e., TR = PQ). Unit elastic demand In the case of unit elastic demand the percentage increase (decrease) in the price of a good or a service is equal to the percentage decrease (increase) in its price, and the value of the price elasticity of demand is negative unity. Total revenue is maximized at the price–quantity combination for which the price elasticity of demand is equal to negative unity.
CHAPTER QUESTIONS 4.1 Suppose that the demand equations for heart surgery and cosmetic surgery are both linear. The demand for heart surgery is more price inelastic than the demand for cosmetic surgery. Do you agree? Explain. 4.2 The price elasticity of demand of gasoline is more elastic in the long run than it is in the short run. Do you agree? Explain. 4.3 Suppose that you are a portfolio manager for a large, diversified mutual fund. The fund’s chief economist is forecasting a slowdown in aggregate economic activity (i.e., a recession). How would you use your knowledge of estimated income elasticities of demand to alter the composition of the portfolio? 4.4 What is the advertising elasticity of demand? What, if anything, can you say about the effect of advertising expenditures on company profits? 4.5 Consider two linear demand curves drawn on the same diagram. The first demand curve has a larger intercept but a numerically smaller (steeper) slope than the second demand curve. What, if anything, can you say about the price elasticity of demand for both goods at the point where the two demand curves intersect? 4.6 What, if anything, can you say about the relationship between the price elasticity of demand for a good and the percentage of an individual’s income spent on that good? 4.7 The price elasticity of demand of a good at a given price is more elastic for wealthy individuals than for individuals who are less affluent. Do you agree? Explain. 4.8 Demonstrate that the market price elasticity of demand is equal to the weighted sum of the individual price elasticities. 4.9 A severe frost significantly damages the Florida orange crop. As a result, revenues earned by Florida orange growers decline dramatically. Do you agree? Explain.
