1- Suppose that the income elasticity of demand for a good is -0.42. This indica
ID: 1203552 • Letter: 1
Question
1- Suppose that the income elasticity of demand for a good is -0.42. This indicates that the good is a(n) ____________ good.
a- complementary
b- substitute
c- inferior
d- normal
____________________________________________________________________
2- Suppose that you sell avocados and you are considering raising the per unit price. If you increase the price by 10% this will decrease the quantity demanded of avocados by 7%. This tells you that increasing the price by 10% will _______________ your total revenue from selling avocados.
increase
decrease
not change
Not enough information.
a- complementary
b- substitute
c- inferior
d- normal
Explanation / Answer
(1) (c)
If income elasticity is negative, it means that as income rises (falls), quantity demanded of a good falls (rises). Such a good is called Inferior good.
(2) (a)
Let initial price: P, initial quantity: Q
Total revenue, TR0: P x Q
After the changes, new price P1 = 1.1P, new quantity Q1 = 0.93Q
New revenue = 1.1P x 0.93Q = 1.023 x P x Q = 1.023 x TR0
So, Total revenue will increase.
Quick-Note: Elasticity = % Change in quantity / % Change in price = - 7% / 10% = - 0.7%
Absolute value of elasticity < 1, so demand is inelastic. With inelastic demand, revenue increases when price increases.
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