Part THREE ELASTICITY Questions Managerial Economics

Question (1)
Price elasticity of demand may lead to price discrimination. Explain this statement in a
suitable detail.
Answer:
Customers has different elasticities towards the products, therefore, a customer maybe
elastic to this product, and another customer is inelastic to the same product, which
usually happen because the price takes small or large portion of customer’s relative
income respectively, accordingly sellers can sell the same product with different prices.
The higher price with the inelastic customer, and the lower price with the elastic
customer.

Question (2)
A good wheat harvest (S↑) will generally lower the income (TR↓) of farmers. Illustrate
this proposition using a supply and demand diagram.
Answer:
Since Wheat is a necessary product, therefore it has an Inelastic demand, and people
are willing to increase their purchases of it just slightly as its price falls.
Accordingly for Farmers (suppliers), the TR (income) will
Inelastic demand curve
As % ΔP↓ > % ΔQ↑ tends to be more sloping
As TR = P x Q P D S
S1
Then TR will decrease following the higher change % for P
both factors (decreasing or increasing) % ΔP↓
Then TR will decease accordingly. P1

Q
Q Q1
% ΔQ↑

Page 1 of 4
 Part THREE ELASTICITY Questions Managerial Economics

Question (3)
Many governments attempt to help farmers by reducing their production. How could
this be in the interests of farmers?
Answer: Inelastic demand curve
tends to be more sloping
The agriculture market products are usually classified as P D S
Necessary products. therefore, these products have S1
inelastic demand. P
% ΔP↓
accordingly, if the production increased for one particular
P1
product, then its price will decrease, however the demand
will not increase or will increase only slightly, which will
make the farmers’ TR decrease, this scenario will might Q
Q Q1
make farmers decide not to produce this product next % ΔQ↑
year, which will cause a shortage in supply.

Question (4)
For each pair of commodities, state which you think is the more price-elastic and give your
reasons.
a. Perfume and salt.
b. Penicillin and ice cream.
c. Ice cream and chocolate ice cream

Answer:
a. Perfume has more price-elastic because it’s not a necessary product, and has substitutes
with different prices.
Salt is an Inelastic product because it’s a necessary product, also, its price to income ratio
is very low, and has no substitutes.
b. Penicillin is an Inelastic product, because it’s a necessary product and has no substitute.
Ice cream is an elastic product compared to penicillin.
c. Chocolate ice cream is more inelastic, because it has a specific characteristic, and specific
customer, who will not accept the normal ice cream.
Ice Cream, is elastic compared to the chocolate ice cream.

Page 2 of 4
 Part THREE ELASTICITY Questions Managerial Economics

Question (5)
Use the following demand and supply schedules for product X to answer the questions
below. Show all work on a graph.

Unit Price Quantity Demand Quantity Supplied

(L.E) (Units) (Units)
300 60 30
400 55 40
500 50 50
600 45 60
700 40 70

a. If the government decided to impose a tax of L.E 300 per unit on product X. What effect
will this have on the market for product X, in general, and on producers and consumers, in
particular?
b. Who bears most of the tax burden? Justify your answer.
Answer:
a. There will be surplus in the market from product X, and less consumers will be able to
afford the new prices, or they might consider a substitute.
(Not sure of this answer is correct or not)

b. As the quantity demanded decreases with the price increase, then product X is a price-
elastic product, therefore the producers will try to bear part of the tax with the
customer, and to find this part %, we need to calculate the PED & PES for product X,
and to do so, we need two points on the supply and demand curves to calculate PED &
PES as following.

Nothing that, price after the tax (P2) will be greater than the original equilibrium price
(P1), and from the available data we can use P2 as 700 L.E.

Note: if the government forces a price ceiling of 200, then P2 should be less than P1, as
demand has different elasticity with prices.

P1 = 500 P2 = 700
% ∆𝑄𝐷 % ∆𝑄𝑆
QD1 = 50 QD2 = 40 𝑃𝐸𝐷 = 𝑃𝐸𝑆 =
% 𝛥𝑃 % 𝛥𝑃
QS1 = 50 QS2 = 70

Page 3 of 4
 Part THREE ELASTICITY Questions Managerial Economics

40 − 50 70 − 50
%ΔQD = ∗ 100 ≈ −22% %ΔQS = ∗ 100 ≈ 33%
(40 + 50)/2 (70 + 50)/2
700 − 500
%ΔP = ∗ 100 ≈ 33%
(700 + 500)/2
−22 33
𝑃𝐸𝐷 = ≈ −0.67 𝑃𝐸𝑆 ≈ =1
33 33

As (ignoring the -ve sign) PED < PES, then the Customers are relatively Inelastic to this
product than the Producers, accordingly, customers will bear the greater part of the tax,
and producers need to keep in their mind the effect of the QD increase on their cost, to
reach the Qs that maximizes their profits.

Question (6)
The demand for unskilled labor is relatively elastic in Egypt and the average level of
wage for unskilled labor is L.E800. If the government decided to place a minimum wage
of L.E1200:

a. how this situation on a suitable graph.

b. What will be the effect of the placed minimum wage on total wages of unskilled labor?
c. What advice could you provide to the Egyptian government in this regard? Explain your
point of view.
d. In case of the demand for skilled labor is relatively inelastic, will the situation change?
Elastic demand curve
Answer:
tends to be Flatter
W S
D
a. Graph → minimum wage will be considered as a
PF = 1200
price floor (PF) for the employers.
W = 800
b. The demand on Unskilled labor will decrease, and
their rate of unemployment will increase.

c. Don’t interfere with the market, as the wages will usually L

decided as per the labor skills level, and if they need a L1 ← DL L
wage increase, they need to change to skilled labors, Unemployment of Unskilled Labors
otherwise the unemployment rates will increase, and
cause more problems.

d. As the demand of the skilled labors are relatively inelastic, the minimum wage will not
affect the market as they usually don’t need it and their wages usually above this
minimum wage, but in sometimes they might need a wage ceiling.

Page 4 of 4