Question

Question 4

a. Explain own price, cross price and income elasticities of demand and how they are measured.

b. Suppose the demand function facing a company manufacturing a particular product (X) is given by

Qx = 62 -2Px + 0.2M + 25A

Where:

Px is the price of the product

M is the consumer income, and

A is the amount of advertising expenditure.

If Px is 4, M is 150 and A is 4

You are required to calculate:

i. The amount of X purchased

ii. The price elasticity of demand. Explain your result

iii. The income elasticity of demand. Is X a normal or an inferior good?

iv. The advertising elasticity of demand. Explain your result.

Answer 1

i) Q = 62 - 2 x 4 + 0.2 x 150 + 25 x 4 = 184

ii) PED = dQ/dP x P/Q = -2 x 4/184 = - 0.0435 (this means that a percent change in price would change (decrease) the quantity demanded by 0.0435%)

iii) IED = dQ/dM x M/Q = 0.2 x 150/184 = 0.163 (this means that a percent change in income would change (increase) the quantity demanded by 0.163%)

iv) AED = dQ/dA x A/Q = 25 x 4/184 = 0.544 (this means that a percent change in advertising expenditure would change (increase) the quantity demanded by 0.544%)