Question

When the price of Milo increases from RM2 to RM3, the quantity demanded decreases from 200 to 150 glasses per month. The demand for Nescafe increases from 50 to 100 glasses per month. (a) Calculate the price elasticity of demand using the midpoint formula. [10 marks] (b) If the price of Milo decreases, what will happen to the total revenue of Milo? Explain. [8 marks] (c) Calculate the cross elasticity of demand between Milo and Nescafe. Based on the answer, explain the relationship between them.

Answer 1

(a) Price elasticity = (Change in quantity / Average quantity) / (Change in price / Average price)

= [(150 - 200) / (150 + 200)] / [(3 - 2) / (3 + 2)]

= (- 50 / 350) / (1 / 5)

= - 0.71

(b) Absolute value of price elasticity being less than 1, demand is inelastic, so if price decreases, total revenue will decrease.

(c) Cross-price elasticity = (Change in quantity of Nescafe / Average quantity of Nescafe) / (Change in price of Milo / Average price of Milo)

= [(100 - 50) / (100 + 50)] / [(3 - 2) / (3 + 2)]

= (50 / 150) / (1 / 5)

= 1.67

Since cross-price elasticity is positive, Milo and Nescafe are substitutes.