Question

Suppose demand function in Europe is Q EU e= 30 - 3/2P, while the Japan demand function is Q JP = 20 -1/2P. Let the price be $8 in both markets. Find and compare price elasticity of demand for each market. What is the effect of a price increase on revenues in the Europe and Japan?

Answer 1

Elasticity of demand = (dQ/dP)*(P/Q)

For europe, dQ/dP = -(3/2), and at P = $8, Q = 30-(3/2)*8 = 18

Hence elasticity of demand for european market = -(3/2)*(8/18) = -2/3

For Japan, dQ/dP = -(1/2), and at P = $8, Q = 20-(1/2)*8 = 16

Hence elasticity of demand for european market = -(1/2)*(8/16) = -1/4

It can be seen that european market is more elastic than japanese market. However, both markets are demand inelastic because absolute value of elasticity of demand is less than 1.

Since both markets are demand inelastic, a price increase will decrease the revenue in both markets. However, the decrease in revenue in european market will be less than that in japanese market because european market is relatively more demand elastic than japan.