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Lesson 2.3 Quiz

This document discusses how to calculate income elasticity of demand using a linear demand function. It provides the formula for income elasticity of demand as the percentage change in quantity divided by the percentage change in income, multiplied by the income coefficient from the demand function. As an example, it shows how to find the income elasticity of 0.05 for a given demand function by taking the income coefficient of 0.1 and multiplying it by income over quantity.

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Kristina Nelson
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154 views

Lesson 2.3 Quiz

This document discusses how to calculate income elasticity of demand using a linear demand function. It provides the formula for income elasticity of demand as the percentage change in quantity divided by the percentage change in income, multiplied by the income coefficient from the demand function. As an example, it shows how to find the income elasticity of 0.05 for a given demand function by taking the income coefficient of 0.1 and multiplying it by income over quantity.

Uploaded by

Kristina Nelson
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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A simple linear demand function may be stated as Q = a - bP + cI where Q is quantity

demanded, P is the product price, and I is consumer income. To compute an appropriate


value for c, we can use observed values for Q and I and then set the estimated income
elasticity of demand equal to:

c(I/Q)

Given Q = a - bP + cI;

Since Income Elasticity of Demand = ( change in Q / change in Income ) x ( I / Q )


NOTE: this is equivalent to taking ( change in Q / change in Income ) x COEFFICIENT ON INCOME

EX: to find the Income Elasticity of Demand, multiply the coefficient of M with M/Q

Change in Q / Change in Income = ( I / Q ) x c

The introduction of refrigerators into American homes:

increased the magnitude of the short run own price elasticity of demand for RAW meat.

Elasticity measures:

the % change in one variable in response to a 1% increase in another variable.


Refer to Figure 2.1. At Point B, demand is:

elastic, but not infinitely elastic.

Inelastic demand implies:

that a 1% increase in price results in a smaller than 1% decrease in QD.

Suppose that the cross price elasticity of demand between goods A and B = 1.5. Which
of the following is TRUE?

A and B are substitutes because the cross price elasticity is positive


Use this demand function to answer the following questions:
QDX = 56 – 2PX
At PX = $8, what is the own-price elasticity of demand for good X?

-0.4000

= 56 - 2(8) = 40 units of good X


= ( -2 ) x ( $8 / 40 units ) = -.4

Use this demand function to answer the following questions:


QDX = 2000 – PX − 2PY + 0.1M + 0.02AX, where PX is the price of Good X, PY is the price of
Good Y, M is the average consumer income and AX is the amount spent to advertise
Good X.
At PX = $100, PY = $100, and M = $1,000, and AX = $10,000 what is the income elasticity of
demand for Good X?

0.0500

= 2000 - (100) - 2(100) + 0.1(1,000) + 0.02(10,000) = 2,000 units of good x


= ( 0.1 INCOME COEFFICIENT ) x ( $1,000 Income / 2,000 units of good x ) = 0.05

Use this demand function to answer the following questions:


QDX = 2000 – PX − 2PY + 0.1M + 0.02AX, where PX is the price of Good X, PY is the price of
Good Y, M is the average consumer income and AX is the amount spent to advertise Good X.
At PX = $100, PY = $100, and M = $1,000, and AX = $10,000 what is the cross-price
elasticity of demand between Good X and the price of Good Y?

-0.1000

= 2000 - (100) - 2(100) + 0.1(1,000) + 0.02(10,000) = 2,000 units of good x


= ( -2 ) x [ $100 / 2,000 units of good x 0 = -0.1

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