Suppose Income Elasticity of Demand is -0.7 for french fries and Cross-Price Elasticity of Demand for...

Suppose Income Elasticity of Demand is -0.7 for french fries and Cross-Price Elasticity of Demand for french fries and pizza is 1.8. Then the following happen: Income increase and the price of pizza goes down. Using a Supply and Demand Model, what happens to the equilibrium price and equilibrium quantity of french fries? Victor Laszlo demands two exit visas. He is willing to pay any price to get them. Draw his demand curve.

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Expert Solution

(Question 1: Elasticity and Demand-Supply)

Income elasticity = % Change in quantity of french fries / % Change in income

-0.7 = % Change in quantity of french fries / % Change in income

% Change in quantity of french fries = (-0.7) x % Change in income

% Change in quantity of french fries < 0, since % Change in income > 0.

Also,

Cross-price elasticity = % Change in quantity of french fries / % Change in price of pizza

1.8 = % Change in quantity of french fries / % Change in price of pizza

% Change in quantity of french fries = 1.8 x % Change in price of pizza

% Change in quantity of french fries < 0, since % Change in price of pizza < 0.

Therefore, in both cases, quantity of french fries will decrease as net effect. This will mean a fall in demand for french fries, which will shift its demand curve leftward, decreasing both price and quantity of french fries.

In following graph, D0 and S0 are initial demand and supply curves for french fries, intersecting at point A with initial price P0 and quantity Q0. As demand falls, D0 shifts left to D1, intersecting S0 at point B with lower price P1 and lower quantity Q1.

NOTE: As per Answering Policy, 1st question is answered.

Rahul Sunny answered 1 year ago

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