Question

You have the following information for goods X and Y:

Goods             Price elasticity            Cross-price elasticity             Income elasticity

X                           -0.5                                  0.5                                              0.8

Y                           -1.8                                  0.2                                           -1.2

Fill out the spaces in the following statements:

• Consider good X. An increase in the price of good X will                   _____ total revenues for suppliers.

• Consider good Y. An increase in the price of good Y will                   _____ total revenues for suppliers.

• Based on the crossprice elasticity, we can say that goods X and Y are _______________

• Based on the income elasticity, we can say that good Y is _________________

• A 10% increase in income will _______________ the sales of good X ______ %

• A 10% increase in the price of good X will _______________________ the sales of Good X _____________ % and __________________ the sales of good Y ____________%

Answer 1

If the demand is inelastic as in this case, then the revenue gained from the increase in price, outweighs revenue lost due to decrease in quantity. Therefore, Revenue will rise. As for good X price elasticity is less than 1 therefore demand is inelastic.

Similarly if demand is elastic, as in case of good Y as price elasticity is greater than 1, then as increase in price would lead to a decrease in revenue.

Since cross price elasticity is positive, which means that increase in price of Y leads to an increase in quantity demanded of X, therefore the goods are complements.

Income elasticity of Y is negative. Which means that an increase in income leads to a decrease in the quantity demanded of Y,. therefore the good is inferior.

Since income elasticity of Y is positive, therefore an increase in income by 10% would lead to an increase in sales of good X by 8%

An increase in price of X by 10% would lead to a decrease in demand of X by 5% (due to negative price elasticity) and an increase in demand of Y by 2% (due to +cross price elasticity)