Problem 2 (8 points) Letters a-f correspond to different values of a dermand or

Question

Problem 2 (8 points) Letters a-f correspond to different values of a dermand or supply elasticity. Match one and only one of these letters to each statement that follows. Each letter may be used for more than one statement or for no statement at all. a. The cross price elasticity of demand is 0.25 b. The cross price elasticity of demand is -0.25 c. The income elasticity of demand is 1.05 d. The income elasticity of demand is 0.05 e. The income elasticity of demand is 0.05 f. The own price elasticity of demand is -1.5 g. The own price elasticity of demand is -1 The own price elasticity of supply is 1.25 i. The cross price elasticity of supply is 0.25 j. The cross price elasticity of supply is 0.20 Statements Letter Statement b Example: The related good is a complementary product to the good in question The good in question is classified as a normal luxury A small increase in the price of the good will decrease revenue to the seller. If the price of this good increases by 2% quantity demanded will fall by 2%. The good in question is an inferior good Demand for this good is elastic The related good is a joint product to the good in question The good in question is classified as a normal necessity Revenue to the seller of this good is maximized

Explanation / Answer

(1) The good is a normal luxary - (c)

[Income elasticity for normal good is positive, and income elasticity for luxury good is higher than 1]

(2) Small increase in price will decrease total revenue - (f)

[Increase in price increases revenue when demand is elastic, so that absolute value of own price elasticity of demand is higher than 1]

(3) If price increases by 2%, quantity falls by 2% - (g)

[Demand is unitary elastic, so % decrease in quantity demanded = % increase in price]

(4) The good is inferior good - (e)

[Income elasticity for inferior good is negative]

(5) Demand for this good is elastic - (f)

[Own price elasticity for elastic good has absolute value higher than 1]

(6) Related good is a joint product - (i)

[Cross price elasticity of supply for joint product is positive]

(7) Good in question is normal necessity - (d)

[Income elasticity for normal good is positive, and income elasticity for necessity good is less than 1]

(8) Revenue to seller is maximized - (g)

[Total revenue is maximized when absolute value of own price elasticity of demand is 1]

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