STUDY EXERCISE 1: SUPPLY AND DEMAND AND

ELASTICTY

Problem 1: Define the following concepts:

(a) Price elasticity of demand

(b) Income elasticity of demand

(c) Cross-price elasticity of demand

(d) Price elasticity of supply

Problem 2. In the table below are some estimates of price elasticities for different
products. Use the estimates to answer the questions below.

Demand elasticities Supply elasticities

Product
Retail level Farm level Short run Long run
Beef -0.64 -0.42 0.31 0.75
Chicken -0.78 -0.60 0.90 1.25
Maize -0.35 -0.20 0.40 1.35

(a) Interpret the value of the price elasticity of demand for beef at the retail level
and at the farm level. Interpret the value of the price elasticity of supply of
maize in the short run and long run.

(b) Which of the elasticities are elastic, inelastic and unitary elastic?

(c) Explain why farm level price elasticities of demand are smaller, in absolute
value terms, than the retail level price elasticities. Does this make sense?

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 (d) Explain why the long run price elasticities of supply are larger in magnitude
when compared with the short-run price elasticities. Does this make sense?
Would you expect long-run price elasticities of demand to be greater than
short-run elasticities? Explain.

Problem 3. The table below presents some hypothetical relationship between

income earned in a day and the number of hamburgers consumed. Study the
data to complete table and answer questions.

Type of good
Income Quantity Income
%  Demand %  Income based on
(€ /day) demanded elasticity
elasticity
-- -- --
10 2

15 4

20 5

30 6

40 4

(a) Calculate the % change in demand and income to compute the income
elasticity of demand

(b) Interpret the value of the income elasticity of demand reflecting a change in
income from $15/day to $20/day.

(c) Explain which type of good a hamburger is at the various levels of income.
Think about what the meaning of the income elasticity is.

(d) Plot the relationship between income and number of hamburgers consumed
in a day. What does the shape of this curve suggest?

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Problem 4. In the table below are some estimates of cross-price elasticities for
different products. Use the estimates to answer the questions below.

Value of the
Product cross-price Type of goods
elasticity
Margarine with respect to the price of butter 1.53
Natural gas with respect to the price of electricity 0.80
Pork with respect to the price of beef 0.40
Clothing with respect to the price of food -0.18
Entertainment with respect to the price of food -0.72
Cereals with respect to the price of fresh fish -0.87

(a) Determine what the relationship is between each of the pairs of goods listed
based on the value of the cross-price elasticity of demand. (Are the two products in
each row in the table substitutes or complements?)

(b) Interpret the value of the cross-price elasticity of demand for margarine
with respect to a change in the price of butter. What do values with a small
magnitude imply relative to higher values?

Problem 5: Consider the market information in the scenarios below and

determine the changes in equilibrium price and quantity. Determine how demand
and supply change and the new equilibrium price and quantity. (Will the supply or
demand shift, and how will the demand or supply curve shift?)

(a) World grain markets. Australia, one of the main world exporters of grain,
has been experiencing the worst drought on record.
(b) World market for beef. China has experienced growth rates in national
income of around 10% per year for several years consecutively. The trends
in income have caused a shift toward more western diets, including more per
capita consumption of meat.

(c) Orange juice markets. There were record yields in major juice-orange
producing regions. At the same time there have been medical reports have
praised orange juice for its health effects.

(d) World oil market. The Organization of Petroleum Exporting Countries

(OPEC) decides to increase production by 10% over the next 5 years.
The US, a major consumer-importer of oil, has sought to reduce its

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dependence on oil by increasing its production of ethanol (made from
maize, in particular). The US goal is to reduce petrol consumption by 20%.