Response to question A
Elasticity of demand is the responsiveness of the demand of a good to changes in other economic variables (Ferguson, 1972). As such, elasticity of demand is important since it helps to determine the potential change in demand due to variation in prices. Elastic demand occurs when the demand of a product changes with respond to price. In Elastic demand is when the demand curve doesn`t respond to change in prices. The response of the consumer is large compared to price change. Unit elastic demand occurs when the absolute value of elasticity equals 1.
Response to question B
Cross price elasticity of demand is the rate of change the quantity required due to the price change of the other commodity (Gillespie, 2007). As such, when two goods are substitutes, consumers tend to purchase more of one good due to increase for the other substitute. Similarly, for complementary commodities, a price increase of a commodity causes a reduced demand for all the goods. Moreover, cross elasticity of demand points out the sensitivity of a particular commodity to price change.
Response to part C
Income elasticity of demand relates on the quantity demanded due to a fluctuation in the consumer income. This can be expressed mathematically as
IEoD= (% change in the quantity demanded)/ (% change in the income) (Gillespie, 2007).
Normal good is good who demand increases as income increases but at lower rate than increase in income. It has appositive demand curve. That is considered as the coefficient of elasticity of N>0 (Ferguson, 1972).Inferior good is good which demand decrease when income increase. In this case, the coefficient of elasticity is N<0. As such a normal product can be classified as either elastic or inelastic depending on the income elasticity value relative to 1(Ferguson, 1972). A superior product exists in the event of increased demand due to a small increase in the income (Gillespie, 2007). The coefficient of elasticity is more than one N>1. Notably, a superior product exhibits the same coefficient of elasticity similar to normal goods.
Response to part D
Substitute goods have a positive cross elasticity. As price for one good rises the demand of the other increases (Ferguson, 1972. A hypothetical example involves the paper clips produced by a company Q. They are standard clips just like those offered by other companies. Thus, company Q sells all its clips at its own specific price, but in case it reduces the price other buyers who may have purchased other clips will instead buy those of company Q. As such if the price is raised, buyers will buy other clips made by other companies.
Response to part E
The proportion of a consumer’s income devoted to a good can be both inelastic and elastic. The greater the proportion of income devoted to a good, the more a consumer is pushed to cut his budget if prices rise making the effect of income and demand elasticity to be greater. For example, if a consumer sets aside $350.00 a month - for gas ($250.00) and concert tickets ($100.00). If the price goes up on gas in a month, the consumer will still buy reflecting an inelastic demand. Since the demand for gas is constant, the funds set aside for concert tickets become highly elastic and funds for gas become inelastic.
Response to E1
The percentage change in the quantity of concert tickets demanded is likely to be greater since concert tickets are less of a necessity, as opposed to gas. As such the demand for concert tickets is more price elastic than the demand for gas, it can also be stated that the demand for gas is more price inelastic than the demand for concert tickets.
Response to part F
Considering a case for an increase in the subway fares, the consumers may take time to adjust to their patterns of consumption and adopt other alternatives. In the short run, the changes in prices makes the demand to be inelastic. The longer the duration after change in price, the more the elastic demand (Gregory, 2012)
Response to part G
Graphs for elasticity of demand, total revenue and price are given below.
Figure 1. The elasticity of demand and total revenue.
In the long-term horizon, these products will start to decrease in price and substitute products will enter the market. However, in the short run or a short – term horizon consumers will generally react only slightly to price hikes as they will not care how much the product costs if it fills a need. In the long run, consumers will have broader choices and will in turn buy more of the substitutes to test them out (Taylor & Akila, 2008)
Figure 2.The elasticity of demand, total revenue and price.
The graphs above illustrate the relationship between the elasticity of demand and the total revenue for a linear demand curve. A decrease in price from $80 to $50 within the elastic range of point P to Q increases the total revenue from $75 to $200. In the unit elastic range between Q and R, any change of the price has no effect on the total revenue within this range, the coefficient of elasticity of demand is equal to 1, and, thus, the total revenue is maximized. However, price decrease from $40 to $0 leads to an inelastic demand between R and S, within this region total revenue reduces from $200 to $0.
Ferguson, E. C. (1972). Microeconomic Theory. Illinois: Richard D. Irwin publishers.
Gillespie, A. (2007). Foundations of Economics. Oxford: Oxford University Press.
Gregory, M. N. (2012). Principles of Macroeconomics. Stamford: Cengage Learning.
Taylor, J. B. (2008). Economics. Stamford: Cengage Learning.