Multiple Choice
A firm may use a price-sales ratio instead of a price-earnings ratio when it has had (negative/positive) earnings over the past year. Which is correct?
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5. Consumer and Producer Surplus; Price Ceilings and Floors
Consumer Surplus and Willingness to Pay
Multiple Choice
The demand for a luxury good whose purchase would exhaust a large portion of one's income is best described as:
A
Unit elastic
B
Perfectly inelastic
C
Inelastic
D
Elastic
Verified step by step guidance1
Understand the concept of price elasticity of demand, which measures how much the quantity demanded of a good responds to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price, expressed as \(\text{Elasticity} = \frac{\% \Delta Q_d}{\% \Delta P}\).
Recall the definitions of elasticity categories: if elasticity is greater than 1, demand is elastic; if it equals 1, demand is unit elastic; if it is less than 1 but greater than 0, demand is inelastic; and if it is 0, demand is perfectly inelastic.
Consider the nature of a luxury good that consumes a large portion of income. Such goods tend to have many substitutes or can be postponed, so consumers are sensitive to price changes, leading to a relatively large change in quantity demanded when price changes.
Recognize that because the quantity demanded changes proportionally more than the price change for luxury goods, their demand is elastic (elasticity greater than 1). This means consumers reduce their quantity demanded significantly when the price rises.
Conclude that the best description for the demand of a luxury good that exhausts a large portion of income is elastic demand, as consumers are responsive to price changes in such cases.
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