2. Suppose a 10% decrease in income of the consumers, has resulted in a 30% incr

Question

2. Suppose a 10% decrease in income of the consumers, has resulted in a 30% increase in the demand for a product (say, product X). Evaluate the Income elasticity of Demand. Is X a normal good or an inferior good? Why? 3. Suppose a 10% increase ! price of a different product (such y), has resulted in a 30% decrease in the demand for OUR product (say, product X). What can you tell about cross elasticity of demand? (Calculate and demonstrate your answer). Are x and y substitutes or complement? Why?

Explanation / Answer

Question 2

The income of consumers has decreased by 10%.

So,

Percentage change in income = -10%

Demand for product has increased by 30%.

So,

Percentage change in quantity demanded = 30%

Calculate the income elasticity of demand -

Income elasticity of demand = % change in quantity demanded/% change in income = 30/-10 = -3

The income elasticity of demand is -3.

The value of income elasticity of demand is negative.

The value of income elasticity of demand is negative in case of inferior good.

So,

X is a inferior good.

Question 3

The price of product y has increased by 10%.

So,

Percentage change in price of y = 10%

The quantity demanded of our product (x) has decreased by 30%.

So,

Percentage change in quantity demanded of x = -30%

Calculate the cross-elasticity of demand -

Cross-elasticity of demand = % change in quantity demanded of x/% change in price of y = -30/10 = -3

The cross-price elasticity of demand is -3.

The value of cross price elasticity is negative in case of complementary goods.

Since, the value of cross-price elasticity of demand between x and y is negative, the x and y are complements.

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