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Review Problems

Review Problems

Review Problems

Review Problems

Problem : Usually, when gas prices go up in the U.S., it is the result of some action by OPEC. How would you explain this, verbally and graphically, using elasticity as part of your argument?

When OPEC decreases supply, moving the supply curve inwards, it results in an increase in price and a decrease in consumption. What makes this situation even worse is that in the short run, American demand for gasoline is relatively inelastic, so that when the supply curve shifts inwards, consumption doesn't decrease much, but the price increases by a lot, since the demand curve is so steep.
Figure %: The Effects of Tightened Oil Supply on the Market for Gasoline

Problem : Why would demand for oxygen be more inelastic than demand for caviar (assuming that you have to buy both goods in order to have them)?

Goods for which demand is inelastic tend to be essential goods or goods without good substitutes. While some might argue that there is no good substitute for caviar, and it is necessary for a good lifestyle, it is still not as essential as oxygen. If there were a market for oxygen and a market for caviar, and buyers have a limited amount of money, they would always choose to buy oxygen, no matter what the price, or else they would die, rendering all markets useless anyway. Caviar, being a non-essential good, would be a lower priority than oxygen, and so demand for it would be more affected by changes in price. This means that demand for oxygen will be inelastic relative to demand for caviar.

Problem : From each pair of goods, pick the good for which demand will most likely be more elastic:

Coffee and water
Rice and ham
Underwear and tuxedos
Velvet and cotton
Coffee makers and espresso machines

The goods for which demand will be more elastic: coffee, ham, tuxedos, velvet, espresso machines

Problem : How is it possible for the elasticity of demand to change over time (in the long run)?

In the short run, demand can often be inelastic, as people are not willing to immediately change their consumption habits with increases in price. If they see that prices are permanently higher, however, they may take steps to change their consumption patterns in order to save money. For instance, if John buys a cup of gourmet coffee every morning at the same coffee shop, and the prices go up, he may continue buying coffee there, making his demand is inelastic: he still buys coffee at the same rate even at a higher price. After a few weeks, however, he notices that it's starting to cost him a lot more to buy coffee every morning. So he might go buy a coffee maker and make his coffee every morning. In the long run, his elasticity of demand is quite high, even though his demand was inelastic in the short run.

Problem : Why would a government tax on cigarettes be an ineffective method to decrease consumption of cigarettes if demand for cigarettes is inelastic?

Putting a tax on cigarettes would have the effect of increasing the price of cigarettes. If demand is inelastic, however, smokers will still buy the same amount of cigarettes, or show a very small decrease in consumption, regardless of the increase in price. The net result of the tax would be a large jump in price with a smaller-than-desired decrease in consumption.