Question

a) The price elasticity of a good is -4.2. What does this mean? What would happen to the total revenue collected if prices were to increase by 10%?

b)The income elasticity of a good is 0.25. What can we conclude about this good? Explain.

c) The cross price of elasticity of a good is -1.5. What can we conclude about this good? Explain.

Answer 1

(A) As per the question if the price elasticity of a goods is -4.2

The negative sign indicates that it is a normal goods showing negative relationship between the quantity demand and price. It means other things remains constant an increase in price may lead to fall in quantity demanded and vice-versa.

Price elasticity is = 4.2 which is greater than one indicates, it is relatively more elastic. Because When Price elasticity > 1, the elasticity of demand for the product is relatively more elastic, it states a proportionate change in price may lead to more than proportionate change in quantity demanded.

When price increases by 10%

According to the percentage method of estimation of price elasticity of demand, Percentage change in quantity / Percentage change in price = price elasticity of demand

Percentage change in quantity / 10 = -4.2

Percentage change in quantity = -42

With a 10% increase in price may lead to fall in quantity demand by 42%, as a result Total revenue will decrease. Because when the price elasticity of demand is relatively more elastic, an increase in price will lead to decrease in total revenue.

Example Suppose price of the product is 10 and quantity demanded is 100 units,

New price (With the 10% increase in price) may lead = 10 + 10% of 10 = 10 + 1 =11

New quantity (Decrease in quantity by 42%) = 100 – 42% of 100 = 100 – 42 = 58

Price	Quantity	Total Revenue = Price x Quantity
10	100	1000
11	58	638

In the above example the price elasticity of demand for the product is relatively more elastic, so an increase in price may lead to decrease in total revenue.

(B) The income elasticity of good is 0.25,

Here the income elasticity of good is positive: which indicates that it is a normal good. Where quantity demanded for the good increases with the increase in income which leads to Positive income elasticity. Where as in contrary negative income elasticity occurs for inferior goods.

Here the income elasticity of good is positive and is < 1 so it is necessary product because

If income elasticity of demand is positive and < 1 then it is necessary good

If income elasticity of demand is positive and > 1 then it is a luxury good

The income elasticity of the good is relatively less elastic, because income elasticity is > 0 and < 1. Which indicates with a proportionate change in income leads to less than proportionate change in quantity demanded. Which is possible in case of necessary goods.

(C) The cross price elasticity of a good is -1.5, which indicates the good is complementary to another goods

Cross elasticity refers to change in the quantity demanded for a commodity due change in the price of its related goods.

Cross price elasticity of demand is = positive, then goods are substitutes to each other

Cross price elasticity of demand is = negative, then goods are complementary to each other

Cross price elasticity of demand is = zero, there exist no relation between the product