Question

1. Suppose the price of chicken rises by 15% and as a result the amount of turkey breast sold rises by 20%. What is the cross elasticity of demand for the products? (Pay close attention to the formula for cross price elasticity. Are they substitutes or complements? How do you know?

2. How would the following changes affect total revenue? Would total revenue increase, decrease or remain the same? Explain in each case.
a. Price falls and demand is elastic
b. Price rises and demand is elastic
c. Price rises and demand is inelastic
d. Price falls and demand is inelastic
e. Price rises and demand is unit elastic

Answer 1

1. Cross price elasticity of demand = Percentage change in quantity demanded of turkey/Percentage change in price of chicken
= 20%/15% = 1.33
So, they are substitutes because as price of chicken increases, its demand decreases and in turn, demand for turkey is increasing which means turkey is a substitute for chicken.

2. Total Revenue = price*quantity
When demand is elastic, percentage change in quantity demanded > Percentage change in price
When demand is inelastic, percentage change in quantity demanded < Percentage change in price
When demand is unit elastic, percentage change in quantity demanded = Percentage change in price

a. Total revenue will increase
When demand is elastic fall in price will lead to greater increase in quantity demanded so total revenue will increase.

b. Total revenue will decrease
When demand is elastic rise in price will lead to greater decrease in quantity demanded so total revenue will decrease.

c. Total revenue will increase
When demand is inelastic rise in price will lead to smaller decrease in quantity demanded so total revenue will increase.

d. Total revenue will decrease
When demand is inelastic fall in price will lead to smaller increase in quantity demanded so total revenue will decrease.

e. Total revenue will remain the same.
When demand is unit elastic then rise in price = fall in quantity so total revenue will remain same.