Question

Problem-solving exercises: (a) Use the arc-approximation formula to calculate the price-elasticity of demand coefficient of a firm's product demand between the (quantity, price) points of (12, $20) and (18, $16). (b) Calculate the cross-price elasticity of demand coefficient of a firm's product X, given that a 10% increase in the price of its close substitute, product Y, causes the quantity demand of product X to increase by 6%. c) Calculate the income-elasticity of demand coefficient for a product for which a 5% increase in consumers' income will increase the quantity demanded by 4%.

Answer 1

b)

Cross price elasticity is calculated by dividing the % change in quantity demanded of good X by the % change in price of good Y.

% change in quantity demanded of good X = 6% increase

% change in price of good Y = 10% increase

Cross price elasticity between X and Y= 6%/10%=0.6.

Since the coefficient is positive, X and Y are substitute goods.

c)

Income elasticity of demand tells us how the demand for a good changes due to change in income, other things remaining the same.

Income elasticity of demand =

% change in quantity demanded/% change in consumers income

= 4%/5%=0.8.

a)