Question

i) Indicate what type of elasticity you are calculating (i.e. price, cross or income elasticity). ii) Then calculate the elasticity coefficient (i.e. what number is the elasticity?). For this exercise use the simple percentage method (as there is not enough information to do the midpoint formula calculation). a) The price of oranges falls by 10% and the quantity of oranges demanded increases from 500 to 600. b) Consumers’ incomes increase by 5% and the quantity of oranges demanded increases from 500 to 515. c) The price of apples falls from $1 to 80 cents and the quantity of oranges demanded falls from 500 to 450. Are apples and oranges substitutes or complements in this case? d) The price of butter increases from a $10 to $12.50 a kilogram and the demand for bread falls by 20%. Are butter and bread substitutes or complements in this example?

Answer 1

(a) Here we compute own price elasticity of demand.

% increase in quantity demanded = (600/500) - 1 = 1.2 - 1 = 0.2 = 20%

Price elasticity of demand = % Change in quantity demanded / % Change in price = 20% / (-10%) = - 2

(b) Here we compute income elasticity of demand.

% change in demand = (515/500) - 1 = 1.03 - 1 = 0.03 = 3%

Income elasticity of demand = % Change in demand / % Change in income = 3% / 5% = 0.6

(c) Here we compute cross price elasticity of demand.

% change in price of apples = ($0.8/$1) - 1 = 0.8 - 1 = - 0.2 = - 20%

% change in demand for oranges = (450/500) - 1 = 0.9 - 1 = - 0.1 = - 10%

Cross Price elasticity of demand = % Change in demand for oranges / % Change in price of apples

= (-10%) / (-20%) = 0.5

Since cross price elasticity is positive, apples and oranges are substitutes.

(d) Here we compute cross price elasticity of demand.

% change in price of butter = ($12.5/$10) - 1 = 1.25 - 1 = 0.25 = 25%

% change in demand for bread = - 20%

Cross Price elasticity of demand = % Change in demand for bread / % Change in price of butter

= (-20%) / 25% = - 0.8

Since cross price elasticity is negative, bread and butter are complements.