Question

A. Assume that a product has an elastic demand. Explain what will occur to the firm’s total revenue if the price of the product is increased.

B. List and explain three (3) factors that could impact price elasticity of demand for a product.

C. What is income elasticity? How is it used by economists?

D. What is cross elasticity of demand? How is it used by economists?

Answer 1

1. If a product has elastic demand, any increase in price of a good will lead to a decrease in total revenue.

This is because the price has a larger impact on the quantity demanded for a good with elastic demand.

2. The three main factors that impact the price elasticity of demand are:-

Income level:- .

As income increases, elasticity of demand decreases and as income decreases, the elasticity of demand increases.

This is because when prices increase or decrease, poor people are highly affected from it while the rich remain indifferent.

Availability of substitutes:-

As number of substitutes increases, demand for that commodity increases because when price of any commodity increases people prefer buying their substitutes.

Time period:-

When the customers have longer time to respond to the price change, demand is said to be more price elastic as they can search for more cheaper substitutes with in this time period.

3. Income elasticity of demand refers to the responsiveness of a good quantity demanded to a change in price of that good.

Economists use income elasticity of demand as the ratio of the percentage change in quantity demanded to percentage change in income.

4. Cross elasticity of demand increases the responsiveness of a good quantity demanded based on the changes in the prices of other goods.

Economists use it as the of percentage change in quantity demanded of any good say A, to the percentage change in the price of any other good say B.