Question

1.      During the winter season in U.S., rain spoils the strawberry crop, the price rises from $4 to $6 a box, and the quantity demanded decreases from 1,000 to 600 boxes a week. Meanwhile, if the general income level of the population is increased from $800 to $1100.

a)      Calculate the price elasticity of demand over this price range.

b)      Calculate the income elasticity of demand.

Answer 1

a ) Price Elasticity of Demand :-

It is a measure of consumers responsiveness inaccordance with product cost changes. The demand elasticity measures the result of changes in various factors like product price etc. Demand elasticity can be measured with the help of the folowing formulae.

2 Types of Price Elasticity of Demand:

1. Elastic - If the price elasticity is greater than 1, then it is said to be Elastic.
2. Inelastic - If the price elasticity is lesser than 1, Then it is inelastic.

Formulae

Demand Elasticity = % of Change in Quantity Demand / % of Change in Economic Variable.

Also, if want to measure the price elasticity of demand, then the formulae will be as follows.

Price Elasticity of Demand = % of Change in Quantity Demand / % of Change in Price

EXAMPLE

In the given scenario, Price Rises from 4$ to 6$. Demand falls from 1000 to 600 boxes. The Price Elasticity of Demand is equal to % Change in quantity demand devided by % Change in Price.

Hence % Change in quantity Demanded = (1000-600) / 1000 = -40%

% Changes in Price = ($6-$4) / $4 = 50%

Hence Price Elasticity of demand = -40 / 50 = -0.8

Since the result is Less than 1, it is Inelastic.

b ) Income Elasticity of Demand :-

It means all other things remain constant, whereas quantity demanded sensitivity for a particular product towards a change in Consumers real income who purchase this product. It can be understand with the help of a following formulae.

5 types of Income Elasticity of Demand :

1. High - Income Rises leads to a Bigger Rise in Quantity Demanded.
2. Low - Change in Income is proportionately lesser than the rise in Quantity Demanded
3. Zero - Income changes, but the Quantity Demanded remain constant.
4. Unitary - Income Rises with same proportionate Rise in Quantity Demanded.
5. Negative - Income Increases, where as Quantity Demanded falls.

Formulae

Income Elasticity of Demand = % Change in Quantity Demanded / % Change in Income.

% Change in Quantity Demanded = (1000-600) / 1000 = -40%

% Change in Income level = (1100-800)/ 800 = 37.5%

Hence Income elasticity of Demand = -40 / 37.5 = -1.06

Hence the Income elasticity of Demand is Negative, because the the income increase from 800 to 1100 along with a decrease in demand ofrom 1000 to 600 boxes.