Question

3. What are the major determinants of price elasticity of demand? Use those determinants and your own reasoning in judging whether demand for each of the following products is probably elastic or inelastic: (a) bottled water; (b) toothpaste; (c) Crest toothpaste; (d) ketchup; (e) diamond bracelets; (f) Microsoft Windows operating system. LO4.1

6. How would the following changes in price affect total revenue? That is, would total revenue increase, decrease, or remain unchanged? LO4.2

1. Price falls and demand is inelastic.
2. Price rises and demand is elastic.
3. Price rises and supply is elastic.
4. Price rises and supply is inelastic.
5. Price rises and demand is inelastic.
6. Price falls and demand is elastic.
7. Price falls and demand is of unit elasticity.

11. Suppose the cross-elasticity of demand for products A and B is +3.6, and for products C and D is −5.4. What can you conclude about how products A and B are related? Products C and D? LO4.5

Answer 1

3. The price elasticity depends upon various factors like:

1. Nature of the commodity.

The necessary commodities like salt kerosene oil, vegetables have inelastic demand.

2. Availability of substitutes.

The demand for goods which have close substitute will have an elastic demand (tea and coffee).

3. Multiple uses

The goods with multiple uses have an elastic demand (electricity) .

4. Postponement of uses.

The demand will be elastic for goods, the consumption of which can be postponed.

5. Income level of the buyer.

The high income consumer does not care about the price. Thus their demand is less elastic. The demand for low income groups is elastic as they are more conscious of price changes.

6. Habit of consumers.

The goods on which the consumers are habitually addicted will have inelastic demand. Example cigarettes and liquor.

7. Proportion of income spent on the commodity.

The goods on which the consumers spent a small portion of their income like tooth paste, shoe polish etc. will have inelastic demand. The goods on which the consumers spent a large part of income like cloth, scooter etc will have an elastic demand.

a) Bottled water is a necessary goods and its demand is inelastic.

b) Tooth paste has many close substitutes and hence its demand is elastic.

c) Crest toothpaste has fewer substitutes and hence its demand is inelastic.

d) Ketchup has many substitutes and thus its demand is elastic.

e) Diamond bracelet is not a necessary good. It is a luxury goods and its demand is elastic.

f) Large number of substitutes like Illumos, Morph OS, Free BSD etc are available for Microsoft window operating system. Thus its demand is elastic.

6. a. When the demand is inelastic, a fall in price does not increase the demand. Thus the total revenue decreases with fall in price. But a rise in price increase the total revenue since the demand does not fall as much.

Answer: decrease.

b. When the demand is elastic total revenue decrease with rise in price and increase with fall in price.

Answer: decrease.

c. When the supply is elastic the producers can reduce the supply of the product in order to retain the gain from price increase. Thus the total revenue increase.

Answer: Increase.

d. When the supply is inelastic the total revenue decrease with increase in price.

Answer: decrease.

e. In case of inelastic demand a rise in price does not produce much fall in demand. Thus total revenue increase.

Answer: increase.

f. When the demand is elastic a fall in price creates more demand and total revenue increase.

g) When the demand is unit elastic, the change in price cause same change in quantity demanded. Thus the total revenue remains the same.

Answer: remain unchanged.

11. The cross elasticity of demand is positive in case of substituted goods and negative in case of complementary goods. The cross elasticity between A and B is + 3.6 . These goods are substituted goods. The cross elasticity between C and D is -5.4. These goods are complementary goods.