Question

7. Identify and explain, whether good X is a normal good or an inferior good; an ordinary good or a Giffen good; a substitute or a complement for good Y, if the demand for good X is described by the demand function X (Px; Py; M) = (M – Px + 5Py). 8. Explain, what exactly is meant by income elasticity of demand and show, how is it calculated. 9. What does the income elasticity coefficient εM=0.5 imply? Provide exact interpretation for this coefficient. 10. Explain, what exactly is meant by price elasticity of demand and show, how is it calculated. 11. What does the price elasticity coefficient εPx= -2 imply? Provide exact interpretation for this coefficient. 12. Explain, what exactly is meant by cross-price elasticity of demand and show, how is it calculated. 13. What does the cross-price elasticity coefficient εPy= 2 imply (in the context of two goods: X and Y)? Provide exact interpretation for this coefficient. 14. Explain, what is meant by unit elastic, elastic and inelastic demand.

Answer 1

7) X=M-Px+5PY

Good is normal because increase in income increases demand of X

Good is ordinary because increase in price of X, decreases demand of X

Y is substitute because increase in price of Y leads to increase in demand of X

8)Income elasticity is the degree of responsiveness of quantity demand due to some % change in income, ceteris paribus. Id=%change in quantity/%change in Income.

9) Em=0.5 it means for 1% increase in income, quantity demand increases by 0.5%.

10)price elasticity of demand is the degree of responsiveness of the quantity demanded due to some %change in price, ceteris paribus.

11) 1% increase in price decreases quantity demanded by 2%, ceteris paribus