Question

Elasticity a. Use two diagrams (one for Alberta, one for the world) to explain why the following might be true: A drought around the world raises the total revenue that farmers received from the sale of grain, but a drought only in Albert reduces the total revenue that Alberta farmers receive.

b. You have the following information about good X and good Y: • Income elasticity of demand for good X: -3 • Cross-price elasticity of demand for good X with respect to the price of good Y: 2 Would an increase in income and a decrease in the price of good Y unambiguously decrease the demand for good X? Why or why not?

c. A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain

Answer 1

a)

The following diagram shows the case for Alberta and Rest of the world when there is drought around the word. When there is a drought around the word, the world faces a shortage of supply as a result there is incresed demand corresponding to the low supply. Due to this Alberta's demand curve shifts to the right leading to higher prices and higher quantity demanded. As a result the overall revenue rises for Alberta.

The following graph shows that when there is a drought in Alberta, the supply falls drastically in ALberta, leading to a shortage, therefore, there is decreased quantity demanded and higher prices and the overall revenue falls because the change in quantity is greater than the rise in prices.

b)

Gievn that Income elasticity of demand for good X: -3

Cross-price elasticity of demand for good X with respect to the price of good Y: 2

Therefore, a negative income elasticity for demand tells us that as income rises the quantity demanded for that good falls, therefore, we can say that the good is an inferior good since income and demand have a negative relation.

A positive cross price elasticity tells us that when the price of good y decreases, demand for good y rises due to the law of demand but since cross elasticity is positive the demand for good x falls as a result we can say that x and y are substitutes.

Therefore when the income rises and the price of good y falls, the demand for good x will unambiguously decrease since it is an inferior good and x and y are substitutes.

c)

Given that quantity demanded for a good decreases while the total revenue of the good increases, therefore, we can say that the increase in total revenue is due to a rise in the prices.

When prices rise and quantity falls, but this leads to an increase in the total revenue, we can say that change is quantity demanded is less than the change in price and as a result the demand for the good is inelastic.