Question

1. A major PC producer lowers the price of its desktop PC from $1,000 to $800. The sale of desktops increases by 25 percent. The sales manager notices that sales of the company’s laser printers increase by 15 percent.

1. Calculate the arc price elasticity of desktop PC. Explain what it means.
2. Why have the sales of laser printers increased? Calculate the arc cross price elasticity of laser printers. Based on your calculation, is a laser printer a substitute or complement? Why?
3. Was the new policy beneficial for increasing the revenues of the producer? Explain.
4. If you were to estimate a demand equation for desktop computers, which variables would you choose as explanatory variables?

Answer 1

a. Arc price elasticity = %change in quantity/ %change in price = 25%/ -20% = -1.25.
This means that demand for desktop is elastic (value is greater than 1).

b. Arc cross price elasticity of laser printers  = 15%/ -20% = -0.75
The cross price elasticity of laser printers is negative.  It means that  desktop and laser printers are complements. When the price of desktop is decreased, its demand increases; so does the demand for its complement, laser printers.

c. Yes, the new policy is beneficial for producers. The demand is elastic. So, according to the property of elasticity, when price decreases, revenue increases. So, producers of desktop will have increased revenue when they decrease the price.

d. Explanatory variable would be price of desktop. Response variable would be the quantity demanded.
When price decreased, the quantity demanded increased. So, explanatory variable is the price which the producers manipulated in order to increase the revenue.