Download Chapter 2

Answers to Pause-for-Thought Questions
Chapter 2
p54 
Why will the price elasticity of demand for a particular brand of a product (e.g. Texaco) be
greater than that for the product in general (e.g. petrol)? Is this difference the result of a
difference in the size of the income effect or the substitution effect?
The price elasticity of demand for a particular brand is more elastic than that for a product in general
because people can switch to an alternative brand if the price of one brand goes up. No such
switching will take place if the price of the product in general (i.e. all brands) goes up. Thus the
difference in elasticity is the result of a difference in the size of the substitution effect.
p57 
If a firm faces an elastic demand curve, why will it not necessarily be in the firm’s interests to
produce more? (Clue: you will need to distinguish between revenue and profit. We will explore
this relationship in the next chapter.)
Even though an increase in production will lead to an increase in revenue for the firm, costs may
increase by more than revenue, thereby reducing the firm's profits. The issue, then, is whether
revenue increases more than costs (in which case the firms will increase its profits by producing
more), or less than costs (in which case the firm would see a fall in profit by producing more).
p59 
Two customers go to the fish counter at a supermarket to buy some cod. Neither looks at the price.
Customer A orders 1 kilo of cod. Customer B orders £3 worth of cod. What is the price elasticity
of demand of each of the two customers?
The elasticity of demand for Customer A is zero. In other words, that person's demand for cod is
independent of price. If the price was different from the actual price, Customer A would still buy
1 kilo.
The elasticity of demand for Customer B is –1. In other words, if price were 10 per cent higher
than the actual price, 10 per cent less cod would be bought in order to keep the amount spent
constant (at £3).
p65 
Assume that you decide to spend a quarter of your income on clothes. What is (a) your income
elasticity of demand; (b) your price elasticity of demand?
(a) Your income elasticity of demand is 1. In other words, a 10 per cent rise in your income
would see you spending 10 per cent more on clothes in order to keep the fraction of your
income spent on clothes at a quarter.
(b) Your price elasticity of demand is –1. To understand this, assume that price changes but that
your income does not. In order to keep your expenditure on clothes at one quarter of you
income, your total expenditure on clothes would have to remain the same, irrespective of
price. This will occur when the price elasticity of demand is unity (–1).
p71 
The demand for pears is more price elastic than the demand for bread and yet the price of pears
fluctuates more than that of bread. Why should this be so? If pears could be stored as long and as
cheaply as flour, would this affect the relative price fluctuations? If so, how?
The reason for the greater price fluctuations of pears is their greater supply fluctuations according
to the season and the different costs of importing pears from other countries when they are in
season there. Holding stocks of a product can help to reduce price fluctuations, as demonstrated in
the text, but the cost of storage must be reflected in the price. Thus if pears could be stored more
Answers to pause-for-thought questions in Essentials of Economics (3rd edition), John Sloman
cheaply, their price would fluctuate less. If they could be stored as cheaply as flour (relative to
their price), then price fluctuations would be similar to that of flour. Whether the degree of price
fluctuation were identical, however, would depend also on how much initial supply (before
storage) fluctuated, assuming storage costs are not zero.
p73 
Draw a supply and demand diagram with the price of labour (the wage rate) on the vertical axis
and the quantity of labour (the number of workers) on the horizontal axis. What will happen to
employment if the government raises wages from the equilibrium to some minimum wage above
the equilibrium?
W
S
surplus
minimum
wage
We
D
O
Qd
Qs
Quantity of workers
Diagram 2.1 Effect on employment of a minimum wage
See Diagram 2.1, which is similar to Figure 2.10 on page 73 of the text, only the wage rate is plotted
on the vertical axis and the horizontal axis plots the quantity of workers rather than the quantity of
goods. Employment will fall to Qd workers. The supply of workers will rise to Qs. There will thus be
unemployment (a surplus of workers) of Qs minus Qd.
2