Question a Suppose the income elasticity of demand for prere

Question:

(a) Suppose the income elasticity of demand for pre-recorded music compact disks is +4 and the income elasticity of demand for a cabinet maker\'s work is +0.4. Compare the impact on pre-recorded music compact disks and the cabinet maker\'s work of a recession that reduces consumer incomes by 10 per cent.

(b) How might you determine whether the pre-recorded music compact discs and MP3 music players are in competition with each other?

(c)   Interpret the following Income Elasticities of Demand (YED) values for the following and state if the good is normal or inferior; YED= +0.5 and YED= -2.5

(d)   Interpret the following Cross-Price Elasticities of Demand (XED) and explain the relationship between these goods. XED= + 0.64 and XED= -2.6

Solution

(a) Suppose the income elasticity of demand for pre-recorded music compact disks is +4 and the income elasticity of demand for a cabinet maker\'s work is +0.4. Compare the impact on pre-recorded music compact disks and the cabinet maker\'s work of a recession that reduces consumer incomes by 10 per cent.

Income elasticity = Percentage change in demand/ percentage change in income

In case of pre recorded music comact disks it is

4 = percentage change in demand/10

Demand will increase by 40%

In case of MP3 music players, it is

0.4 = percentage change in demand/10

Percentage change in demand = 4%

(b) How might you determine whether the pre-recorded music compact discs and MP3 music players are in competition with each other?

We can determine it thorugh their cross elasticity. If cross elasticity for two goods is positive thenthey are in competition.

(c)   Interpret the following Income Elasticities of Demand (YED) values for the following and state if the good is normal or inferior; YED= +0.5 and YED= -2.5

Goods for which income elasticity is positive is a normal good and good for which income elasticity is negative is inferior because demand for normal goods increases with increase in income and vice versa and demand for inferior goods decreases with increase in income and vce versa.

(d)   Interpret the following Cross-Price Elasticities of Demand (XED) and explain the relationship between these goods. XED= + 0.64 and XED= -2.6

In first case two goods are substitutes and in second case two goods are complementary.