On the basis of the following information, please calculate cross elasticity: De
ID: 1118647 • Letter: O
Question
On the basis of the following information, please calculate cross elasticity: Delta American P1 = $450 Q1 = 200 tickets P2 = $500 Q2 = 360 tickets Show all work. How would you interpret your answer? Is this elastic or inelastic, Why? Are the two goods substitutes or compliments?
On the basis of the flowing information please calculate income elasticity. How would you interpret your answer? (Note: this is the problem from the elasticity slides) Be complete. Y1 = $30,000 Q1 = 800 units Y2 = $31,000 Q2 = 900 units
If a firm increases its price, would its revenue increase or decrease? Why?
Explanation / Answer
1.
Cross elasticity = % change in demand of one product / % change in price of another product
Cross elasticity = ((360-200)/200)/((500-450)/450) = 7.2
If midpoint formula of elasticity is used,
Cross elasticity = ((360-200)/(360+200)/2)/((500-450)/(500+450)/2) = 5.43
Since, the value of cross elasticity is greater than 1, then it is relatively elastic in nature.
Since, the change in price and change in demand are in the same direction, then these two products are substitutes.
Here, increase in price of one product, is increasing the demand of seats of another airlines. It is the case of substitutes.
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2.
Income elasticity = % change in quantity demanded /% change in income
Income elasticity = ((900-800)/800)/((31000-30000)/30000) = 3.75
Since the value of income elasticity is greater than 1, then it is elastic in nature.
With increase in price of product, revenue will increase, because there is 3.75% increase in demand with 1% increase in income, the good is luxurious good and people will go on to buy the product. Demand of luxurious goods are relatively inelastic in nature. Hence, rising the price will make lesser impact upon the demand.
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