1.2.3 Price, income and cross elasticities of demand Quiz: Pearson Edexcel Economics A, Unit 1

The 20 questions

1. What is price elasticity of demand (PED)?

   • The change in quantity demanded resulting from a one-pound change in the price of a related good.
   • The responsiveness of quantity supplied to a change in consumer income, measured in percentage terms.
   • The change in the total amount of money spent on a good, measured in pounds, after a price change occurs.
   • Responsiveness of quantity demanded to price: the percentage change in quantity demanded divided by the percentage change in price.

2. A price rises by 10 per cent and quantity demanded falls by 25 per cent. What is the price elasticity of demand?

   • -2.5, so demand is relatively elastic.
   • -0.4, so demand is perfectly inelastic over this range.
   • 0.4, so demand is relatively inelastic.
   • +2.5, so demand is relatively inelastic and the good is a luxury.

3. A price falls by 5 per cent and quantity demanded rises by 2 per cent. What is the price elasticity of demand?

   • -2.5, so demand is relatively elastic.
   • +0.4, so demand is relatively elastic because quantity rose.
   • -1.0, so demand is unitary elastic at this price.
   • -0.4, so demand is relatively inelastic.

4. Which value of price elasticity of demand indicates unitary elasticity?

   • A value of 2, where quantity demanded changes twice as much as the price change in percentage terms.
   • A value of infinity, where any change in price causes quantity demanded to fall to zero.
   • A value of 0, where quantity demanded does not change at all as price changes.
   • A value of 1 in magnitude, where the percentage change in quantity equals the percentage change in price.

5. Income elasticity of demand (YED) for a good is calculated as 3 divided by 1.5. What is the classification of this good?

   • An inferior good, since a positive income elasticity always indicates that the good is inferior.
   • A giffen good, since demand rises with price when income is held constant in the model.
   • A normal good that is income elastic, since YED = 2 is positive and greater than 1.
   • A necessity that is income inelastic, since YED is less than the price elasticity of demand.

6. A consumer's income rises by 4 per cent and demand for a good falls by 2 per cent. What is the income elasticity of demand and what type of good is it?

   • -0.5, so the good is inferior.
   • +2, so the good is a luxury good that is income elastic.
   • -2, so the good is a normal good with perfectly elastic demand.
   • +0.5, so the good is a normal good and relatively income inelastic.

7. Cross elasticity of demand between good A and good B is +1.5. What is the relationship between these goods?

   • They are substitutes, since a rise in the price of B increases demand for A.
   • They are complements, since a rise in the price of B reduces demand for A.
   • They are inferior goods, since cross elasticity is positive only for inferior goods in the market.
   • They are unrelated, since cross elasticity is only meaningful for goods with the same price.

8. The price of good B rises by 10 per cent and demand for good A falls by 6 per cent. What is the cross elasticity of demand?

   • +0.6, so the goods are substitutes.
   • -1.67, so the goods are complements that are relatively elastic.
   • -0.6, so the goods are complements.
   • +6, so the goods are substitutes that are relatively elastic in demand.

9. Which factor is most likely to make demand for a good more price elastic?

   • The consumer has few alternatives and the good is needed for daily life.
   • The good has many close substitutes available in the market.
   • The good is a necessity with no close alternatives for consumers to switch to.
   • The good takes up a very small share of the consumer's total budget and is habitual.

10. Which factor is most likely to make demand for a good less price elastic?

    • The good is a necessity with few or no close substitutes.
    • The good has many close substitutes that consumers can switch to easily.
    • The good is defined very narrowly, so many alternatives exist for consumers to choose instead.
    • The good takes a large share of consumer spending and consumers search widely for alternatives.

11. A firm is considering a price cut. Its demand is price elastic. What will happen to total revenue after the cut?

    • Total revenue is unchanged, since elasticity is always equal to one for any firm in the market.
    • Total revenue rises, since the percentage rise in quantity demanded is greater than the percentage fall in price.
    • Total revenue falls, since the percentage fall in price is always greater than the rise in quantity.
    • Total revenue rises only if demand is perfectly inelastic, since quantity demanded does not respond at all.

12. A firm's demand is price inelastic. It raises the price by 8 per cent. What happens to total revenue?

    • Total revenue is unchanged, since the price rise and quantity fall offset each other exactly here.
    • Total revenue falls to zero, since demand is perfectly inelastic and consumers buy nothing at the higher price.
    • Total revenue falls, since any rise in price reduces the revenue earned by a firm in every case.
    • Total revenue rises, since the fall in quantity demanded is proportionally smaller than the rise in price.

13. Total revenue is 400 pounds at a price of 10 pounds, selling 40 units. The price falls to 8 pounds and quantity rises to 60 units. What is the change in total revenue, and what does it show about elasticity?

    • Total revenue rises from 400 to 480 pounds, so demand is price elastic over this range.
    • Total revenue is unchanged at 400 pounds, so demand is unitary elastic over this range of prices.
    • Total revenue falls from 400 to 320 pounds, so demand is price inelastic over this range.
    • Total revenue rises from 400 to 600 pounds, so demand is perfectly elastic over this range.

14. A government raises an indirect tax on a good with inelastic demand. What is the likely effect on the government's tax revenue?

    • Tax revenue is unchanged, since demand elasticity has no influence on how tax revenue responds.
    • Tax revenue is likely to rise, since consumers buy nearly the same quantity despite the higher price.
    • Tax revenue falls, since the tax makes consumers buy far less of the good in every case.
    • Tax revenue falls to zero, since inelastic goods are never bought once they are taxed by the government.

15. A firm faces income elastic demand for its good. What does this suggest about how its sales respond to economic growth?

    • Sales are likely to rise sharply when incomes rise, since the percentage change in demand exceeds the percentage change in income.
    • Sales are likely to remain constant, since income elastic goods are always necessities in the economy.
    • Sales are unaffected by income changes, since income elasticity only matters for the price of the good.
    • Sales are likely to fall sharply when incomes rise, since the good must be an inferior good in every case.

16. Which of the following would be a complement to a car, according to cross elasticity of demand?

    • Petrol, since a rise in its price reduces the demand for cars.
    • Public transport, since a rise in its price increases demand for cars.
    • Clothing, since it is bought with the same income as cars by consumers.
    • Bicycles, since they can be used as an alternative to cars in cities.

17. Evaluate: why might the price elasticity of demand matter to government when it sets an indirect tax?

    • Only the income elasticity matters, since indirect taxes are paid out of income rather than through prices.
    • Elasticity has no influence on tax revenue, since governments can always raise revenue at any level of demand.
    • Government should always tax goods with elastic demand, since consumers never change their behaviour after tax changes.
    • Elastic demand causes a large fall in quantity, limiting tax revenue, while inelastic demand gives steadier revenue.

18. A business reports that a 5 per cent rise in the price of its product led to a 1 per cent fall in sales. What is the PED and what should the business consider?

    • PED is -0.2, so demand is inelastic; a price rise may raise revenue, but the firm should also consider competitors and future sales.
    • PED is -5, so demand is elastic; the firm should cut prices immediately to raise its total revenue.
    • PED is +0.2, so demand is elastic and the firm must reduce its output to restore profitability.
    • PED is -1.0, so demand is unitary and any price rise leaves revenue unchanged in the market.

19. A product is consumed by households whose income falls. The product's demand falls by 12 per cent when income falls by 4 per cent. What is YED and what does this indicate?

    • YED = -3, so the good is an inferior good with income elastic demand.
    • YED = -0.33, so the good is an inferior necessity with income inelastic demand.
    • YED = 0.33, so the good is a necessity with income inelastic demand.
    • YED = 3, so the good is a normal luxury good with income elastic demand.

20. Which pair of goods would be expected to have a negative cross elasticity of demand?

    • Tea and coffee, since a higher coffee price raises the demand for tea.
    • Printers and ink cartridges, since a higher ink price reduces the demand for printers.
    • Bus travel and rail travel, since a higher rail fare raises the demand for buses.
    • Butter and margarine, since a higher margarine price raises the demand for butter.

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