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A service provider finds out income elasticity of Demand for its product is equal to -0.75....

A service provider finds out income elasticity of Demand for its product is equal to -0.75. The area’s economy likely to experience a recession and the firm will not be able to avoid its impact. First, what will happen to the market price and quantity of the firm’s output (typical demand and supply graph)? Support your answer graphically. If the authorities fix the price at the original value, what would be the impact of that on the market?

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Answer #1

Incoem elasticity of demand=-0.75. Hence the good is an inferior good.

Due to recession, the income falls, the demand for the inferior product will rise from D to D'. It will lead to rise equilibrium price from P* to P' and rise in Equilibrium quantity from Q* to Q'.

If the authorities fix the price at original value, there would be excess demand in the market.

At the original Price P*, Qd>Qs, so there is shortage in the market.

Q^~

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