Question

 

4. You get a new job that increases your annual salary by 10%. With a higher salary, your demand for steaks decreases by 2%. Calculate the income elasticity of demand for steaks. Indicate if the good is normal or inferior.

5. The price of a hamburger at McDonald’s increases from $2.50 to $3.00. As a result, the quantity demanded for hamburgers at Burger King increases from 500 to 600 per day. Calculate the cross-price elasticity of demand. Indicate the relationship between the goods (compliment, substitute or unrelated).

Answer 1

4. Income elasticity of demand = % change in demand / % change in income

                                                 = -2% / +10%

                                                 = -0.2

We know positive IED is associated with normal good and negative IED is associated with inferior good

Since IED is negative, therefore, the good is inferior good.

5. P_M1 = 2.50 and P_M2 = 3

    Q_B1 = 500    and    Q_B2 = 600

Cross price elasticity of demand = (Q_B2 - Q_B1) / (P_M2 - P_M1) * (P_M1 + P_M2) / (Q_B1 + Q_B2)

                                                    = (600 - 500) / (3 - 2.50) * (2.50 + 3) / (500 + 600)

                                                    = (100 / 0.50) * (5.50 / 1100)

                                                    = 550 / 550

                                                     = 1

We know a positive CPED is associated with substitutes and a negative CPED is associated with complementary goods.

Since CPED is positive, therefore, the relationship between the goods is substitute.