From the scenario for Katrina’s Candies, examine the procedure Herb will use to
ID: 1200097 • Letter: F
Question
From the scenario for Katrina’s Candies, examine the procedure Herb will use to estimate the "demand model" for this product and comment on the expected price elasticity, income elasticity, and cross price elasticity of demand. That is, do you expect demand to be price elastic or inelastic? Will the income elasticity suggest Katrina Candies is a luxury or a necessary good? And, is there likely to be a strong cross price elasticity with the other products Herb included in his demand model? Explain your answers.
What can you determine about consumer demand for a product whose estimated demand elasticities are as follows:
Price Elasticity of demand is -0.85
Income Elasticity of demand is 2.5
Cross Price Elasticity of demand with this product and your product is -2
Explanation / Answer
Since, price elasticity of demand is less unitary elastic when change in quantity demanded in response to change in the price of the commodity is such that total expenditure on the commodity decreases when price falls and total expenditure increases when price rises. In this case, demand of the good is inelastic.
The income elasticity of demand is 2.5 which shows that when income of person increases by 1% then, quantity demand of the commodity increases by 2.5%. There is direct relationship between the income of the consumer and quantity so, Katrina's candies is a normal good because it have positive income effect.
Cross price elasticity of demand shows the responsiveness of change in the quantity demanded of a commodity due to change in the price of other good. Since, cross price elasticity of demand is - 2, that means when price of other good decreases by 1% then demand of our product decreases by 2%. It shows that goods are complements of each other.
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