Question

2. For each of the following examples, fill in the space by applying the appropriate calculation. a) If the income elasticity of demand for wine is 2, then a 5% increase in consumers' incomes will lead to a _______ % increase in quantity demanded. b) The cross elasticity of demand for Paul’s Pizzas with respect to his major competitor Pam’s Pizzas is 1. This means that if Pam offers a 20% discount on her pizzas, and Paul leaves the price of his unchanged, he will experience a ______% decrease in demand. c) If the cross elasticity of demand between pizzas and garlic bread (assuming they are complementary products) was (minus) - 2, Paul could restore the demand for his pizzas to the original level (before Pam’s competition) by offering a ___% discount on garlic bread.

Answer 1

(a) Income elasticity = % Change in demand / % Change in income

2 = % Change in demand / 5%

% Change in demand = 5% x 2 = 10%

(b) Cross price elasticity = % Change in demand for Paul's pizza / % Change in price of Pam's pizza

1 = % Change in demand for Paul's pizza / (-20%)

% Change in demand for Paul's pizza = (-20%) x 1 = - 20% (decrease)

(c) Cross price elasticity = % Change in demand for pizza / % Change in price of garlic bread

- 2 = (-20%) / % Change in price of garlic bread

% Change in price of garlic bread = (-20%) / (-2) = 10%