Question

Compute and discuss elasticities for the following cases:

When consumer income increases by 4%, the demand for Ramen Noodles decreases by 6%. What is the income elasticity for Ramen Noodles? Explain what this income elasticity measure tells you.

When the price of bread increases by 7%, the demand for butter decreases by 9%. What is the cross-price elasticity? How are the two goods related – are they substitutes or complements? Explain why.

When the price of pork increases by 8%, the quantity of lamb purchased increases by 5%. What is the cross price elasticity? How are the two goods related - are they substitutes or complements? Explain why.

Answer 1

When consumer income increases by 4%, the demand for Ramen Noodles decreases by 6%. What is the income elasticity for Ramen Noodles? Explain what this income elasticity measure tells you.

Income Elasticity = % Change in Q/% Change in I, where Q is the quantity and I is the income

Ie = -6/4 = -1.5, negative income elasticity shows that with an increase in income the demand fell. So the good may be considered as INFERIOR.

When the price of bread increases by 7%, the demand for butter decreases by 9%. What is the cross-price elasticity? How are the two goods related – are they substitutes or complements? Explain why.

Cross Price Elasticity = % Change in Quantity Demanded for Good X/%Change in Price of Good Y, where X and Y are related goods.

=-9/7 = -1.29

Increase in the price of bread has resulted in decreased demand for butter. This means the two goods are complements and the price of one good will negatively affect the demand for another.

When the price of pork increases by 8%, the quantity of lamb purchased increases by 5%. What is the cross price elasticity? How are the two goods related - are they substitutes or complements? Explain why.

Cross Price Elasticity = % Change in Quantity Demanded for Good X/%Change in Price of Good Y, where X and Y are related goods.

=5/8 = 0.625

The goods may be considered as substitutes with a positive relation between the two related goods. The demand for lamb has increased due to increase in price of pork. When pork has become relatively cheaper some consumers have shifted to Lamb.