From the scenario for Katrina’s Candies, examine the procedure Herb will use to

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 that 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 I would like you to think about this simple formula for predicting the change in total revenue when there is a given percentage change in price. Using the example above, if ED (price elasticity of demand) is -.85, then a 10% increase in price will cause the quantity demanded to fall by 8.5%, (-8.5% / 10% = -.85). The Formula for Predicting % Changes in Total Revenue is: %TR = %Q + %P where TR = Total Revenue, Q is Quantity Demanded and P = price. Using this formula, what would be the % in TR if ED is -.85 and the %P is 10%?

Explanation / Answer

Cross Price Elasticity of demand with this product and your product is -2. Negative Cross Price elasticity means If price of related good increases demand of this good will decrease along with demand of related good. That means they are complimenatry goods which are used together like car and gasoline.

  % Changes in Total Revenue is: %TR = %Q + %P

%P is 10% & %Q = (- 8.5%), ;  %TR = 1.5%

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