The formulas for income elasticity of demand crossprice elas

The formulas for income elasticity of demand, cross-price elasticity of demand, and other elasticity concepts are quite similar to that for price elasticity of demand. The only change needed is the substitution of income or price of another good for the price of the good itself in the formula for calculating price elasticity of demand. Interpretation of the elasticity coefficient is a bit different. For income elasticity of demand, if the coefficient Ev is positive the good is referred to as a \"normal good,\" and if E is negative the good to considered an \"inferior good.\" (\"Inferior\" in this usage does not imply poor quality or flawed products, it just means as consumer income increases consumers want to buy less of the good in question.) For cross-price elasticity of demand, if the coefficient EAB is positive the goods are considered \"substitutes,\" and if EAB is negative the goods are considered \"complements. . A 10 percent increase in income brings about a 15 percent decrease in the demand for instant soup What is the income elasticity of demand for instant soup? 10. Given your previous answer, is instant soup a normal good or an inferior good? 11. Calculate the cross-price elasticity of demand for products coffee and tea with the following information: when the price of coffee is $1.40, the quantity sold of tea is 80 cups; when the price of coffee is raised to $1.80, then 120 cups of tea are sold 12. Assume the quantity demanded of strawberry jam fell by 2% when the price of peanut butter rose 10%. Calculate the cross-price elasticity of demand between tea and coffee 13. Given your previous answer, are strawberry jam and peanut butter complements or substitutes? 14. A 10 percent increase in the price of cheeseburgers at a local lunch shop would cause a 5 percent drop in total revenue from cheeseburgers and a 10 percent drop from soft drinks. The company currently sells $1,000 in cheeseburgers and $1,000 in soft drinks each day. Assuming no other effects, would the price increase raise or lower total revenue for the local lunch hop? Explain

Solution

9. Income Elasticity of demand = % change in quantity demanded / % change in income

Income Ed = - 15/10 = - 1.5

10. Instant soup is inferior good because increase in income decreases demand of instant soup.

11. Cross price elasticity = % change in quantity demanded of good X / % change in price of good Y

= % change in quantity demanded of tea / % change in price of coffee

P₁ = 1.40, P₂ = 1.80, Q₁ = 80 and Q₂ = 120

Cross price Ed = (P1 + P2)/(Q₁ + Q₂) x (Q₂ - Q₁)/(P₂ - P₁) = 3.20/200 x 40/0.40 = 8/5 = 1.6