Suppose the own price elasticity of demand for good X is -3, its income elastici

Question

Suppose the own price elasticity of demand for good X is -3, its income elasticity is 1, its advertising elasticity is 2, and the cross-price elasticity of demand between it and good Y is -4. Determine how much the consumption of this good will change if:

Instructions: Enter your answers as percentages. Include a minus (-) sign for all negative answers.

a. The price of good X decreases by 5 percent.

percent

b. The price of good Y increases by 8 percent.

percent

c. Advertising decreases by 4 percent.

percent

d. Income increases by 4 percent.

percent

Explanation / Answer

(a)

Own price elasticity of demand being - 3, an 1% decrease in price will increase quantity demanded of the good by 3%.

So, when price is reduced by 5%, quantity demanded will increase by (3 x 5%) = 15%.

Change in consumption = 15%

(b)

Cross price elasticity between x and Y is - 4, signifying that as price of Y increases by 1%, quantity demanded of X decreases by 4%.

So, when price of Y increases by 8%, quantity demanded of X decreases by (4 x 8%) = 32%.

Change in consumption = - 32%

(c)

Advertising elasticity is 2, therefore if advertising expense is decreased by 1%, quantity demanded of X decreases by 2%.

So, as advertising expense is decreased by 4%, quantity demanded of X decreases by (4% x 2) = 8%.

Change in consumption = - 8%

(d)

Income elasticity being 1, an 1% increase in income will increase the quantity demanded of X by 1%.

So, a 4% increase in income will increase quantity demanded by 4%.

Change in consumption = 15%

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