The demand for Penns Oil motor oil can be characterized by t

The demand for Penn’s Oil motor oil can be characterized by the following elasticities

Price elasticity = – 2.5; Cross Price Elasticity with Value Lean Motor Oil = 1.5; ad Income Elasticity equal to 0.75. Indicate whether each of the following statements is True or False and explain your answer.

1. A price increase for Penn’s Oil will decrease both the number of units demanded and the total revenue of the seller.

2. The cross price elasticity indicates that a 2 % price increase in the price of Value Lean motor oil will increase the demand for Penn’s Oil by 3 %.

3. Motor oil is a normal good

Solution

1. True . The Price elasticity of demand is greater than 1 in absolute terms indicating that Penn oil is a elastic good. Therefore an increase in price will lead to a decline in number of units demanded. Revenue = Price * quantity demanded . For an elastic good ( - < E_d < -1), the decline in quantity demanded is more than the increase in price. Therefore, Total revenue for the seller declines with an increase in price.

2. True . Here Cross price elasticity of lean oil = % increase in demand of Penn oil/% increase in price of lean oil = 3%/2%=1,5 (already given in the statement). A positive cross price elasticity indicates that the goods are substitutes. So increase in price of lean leads a to the increase in demand of the substitute (in this case Penn oil).

3. True . Normal goods are any goods for which demand increases when income increases, and demand falls when income decreases but price remains constant. Income elasticity of demand for normal goods are positive.Here income elasticity of Penn motor oil is 0.75 (positive). Therefore it is a normal good.