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Elasticity quiz answers

The questions:

1. Give an example of something where you would expect demand to be price elastic. Explain why.
2. Give an example of something where you would expect demand to be price inelastic. Explain why.
3. Give an example of something where you would expect demand to be income elastic. Explain why.
4. Here's a good one: give an example of something where you would expect demand to be negatively price elastic; that is a good or service where an increase in price would actually lead to an _increase_ in demand.

king_of_wrong gave some good answers, so I'll go with those:

1. "Books - optional luxury goods, and releasing new hardbacks at 50% discount seems intended to exploit elasticity."
Almost a good answer - optional goods tend to be price elastic, and books certainly look like optional luxury goods; hardbacks more so. However, consider this - hardback books cost a lot more than paperbacks to buy but only a small amount more to produce. eBooks cost much the same as hardbacks (for new books that is) but have almost no marginal cost of manufacture. If hardbacks and eBooks were price elastic, then publishers could reduce the price but sell proportionately more and increase their revenue. They don't, which suggests that _newly published_ hardbacks and eBooks are actually price inelastic. What is going on is that there are enough people out there who really want the latest George R R Martin and want it as soon as possible even if that means paying a significant premium.

2. "Bread - got to eat something, no matter how much it costs."
This is better than a good answer because it allows me to neatly link into something I wanted to talk about in question 4. But yes, basic foodstuffs are pretty much always price inelastic.

Another reason for something to be price inelastic is if its cost is trivial. A good example of this would be a box of matches. How often do you buy matches? Do you even know how much boxes of matches cost? Probably not, but I bet you know they don't cost very much. Which means that you probably don't care too much about price - hence price inelastic.

3. "BMWs - easy to make an old car last a bit longer if income is tight, a nice treat if it's not."
Yeah, I think BMWs - as the sort of car bought by people at the upper end of middle incomes - fit the bill of being income elastic quite well. Many other car marques (or 'new cars' in general) probably also work as an example. Super-luxury cars (let's say a Bugatti Veyron) are probably less income elastic since they are generally only bought by the super-rich. If Roman Abramovich has his income halved, he can still easily afford to buy a Veyron. If Joe Bloggs has his income halved, he ain't buying a new 3 series.

4. "Bling - the more the price goes up, the better to flaunt one's wealth."
There is an element of truth to this. I have heard it suggested that Cristal champagne is by no means the best fizzy wine, but because it is the most expensive (or one of the most), it has become the fizzy wine to be seen with for footballers, hip hop artists and city traders. Hence demand for Cristal has actually increased because of its high price. This effect is probably quite rare, and goods that fit the description are called 'Veblen goods', after the American economist who first described it, Thorstein Veblen. (It is from Veblen that we also get the phrase 'conspicuous consumption'.)
There is another mechanism for negative price elasticity which has nothing to do with conspicuous consumption. In his answer to question 2, king_of_wrong gave bread as an example of a good with price inelastic demand. But what if you were very poor and spent most of your income on bread? If the price of bread increased, you might not be able to buy any other cheap food but you would no longer be able to buy the odd bit of meat that you were used to. Maybe you'd actually buy more bread because you still needed food. Goods like this might actually be entirely theoretical. They are called 'Giffen goods' after the Scottish economist Sir Robert Giffen whom Alfred Marshall (one of the most important economists of the late 19th / early 20th century) credited with observing this relationship among the 19th century poor in Britain.



( 4 comments — Leave a comment )
Jan. 5th, 2011 01:48 pm (UTC)
I think Giffen goods might only exist when food choices are limited. In this country and time, if the price of rice goes up, you can always switch to potatos.
Jan. 5th, 2011 02:55 pm (UTC)
Definitely true - the absence of suitable substitutes is a prerequisite.
Jan. 7th, 2011 09:50 am (UTC)

Is it possible that there are (at least) two groups for books? (Tempted to call them "fractions", like in chemistry...)

The must-have-it-now fans who'll camp out, dressed as Harry Potter characters, for when they open at midnight, and for whom demand is inelastic. And the yeah-I-like-it-and-will-buy-in-hardback-but-maybe-not-today group, for whom demand is elastic, and they're motivated by the price drop. So the price is a compromise between their demands?

Or is it more simply that the 'real' price of a hardback is 50% lower than the RRP, and the extra represents the cost of maintaining stocks of something no longer at #1 on the "top sellers" chart for months on end?
Jan. 7th, 2011 10:07 pm (UTC)
Almost certainly. With these things, individual customers' demand curves will always be elastic to different degrees.
( 4 comments — Leave a comment )