Q2Managerial Economics & Financial Accounting

Question

Calculate and also comment on degree of elasticity: (4\times2.5=10) a) The price of tea per cup is decreased from Rs. 4 to Rs. 3 and the demand of coffee is increased from 2 cups per day to 4 cups per day. Calculate Cross Elasticity of Demand. b) Mr. Gupta's income is raised from Rs. 10,000 to Rs. 15,000 and the demand for good A is raised from 500 to 800 units. Calculate Income Elasticity of Demand. c) The demand of commodity X is raised from 200 to 250 units when price decreased from Rs. 8 to Rs. 6. Calculate Price Elasticity of Demand. d) If the price rises of good A rises from Rs. 20 to Rs. 30. Its supply increases from 200 to 800 units. Calculate Elasticity of Supply.

Answer 1

a) Cross Elasticity of Demand (Coffee vs Tea) $P_{t e a}$ drops from 4 to 3 ( $Δ P = - 1$ ). $Q_{co f f ee}$ rises from 2 to 4 ( $Δ Q = + 2$ ). $E_{cr oss} = (\frac{Δ Q _{c}}{Δ P _{t}}) \times (\frac{P _{t 1}}{Q _{c 1}}) = (\frac{2}{- 1}) \times (\frac{4}{2}) = - 2 \times 2 =$ $- 4$ . Comment: The negative sign indicates they are strong Complementary Goods in this specific scenario (unusual for tea/coffee, but mathematically sound based on data). Highly elastic.

b) Income Elasticity of Demand Income rises from 10k to 15k ( $Δ Y = + 5000$ ). Q rises from 500 to 800 ( $Δ Q = + 300$ ). $E_{in co m e} = (\frac{Δ Q}{Δ Y}) \times (\frac{Y _{1}}{Q _{1}}) = (\frac{300}{5000}) \times (\frac{10000}{500}) = (\frac{3}{50}) \times 20 =$ $+ 1.2$ . Comment: Since $E > 1$ , it is Income Elastic. The good is a Normal/Luxury Good.

c) Price Elasticity of Demand P drops from 8 to 6 ( $Δ P = - 2$ ). Q rises from 200 to 250 ( $Δ Q = + 50$ ). $E_{p} = (\frac{Δ Q}{Δ P}) \times (\frac{P _{1}}{Q _{1}}) = (\frac{50}{- 2}) \times (\frac{8}{200}) = - 25 \times \frac{1}{25} =$ $- 1$ . Comment: Ignoring the sign, magnitude is exactly 1. It is Unitary Elastic.

d) Price Elasticity of Supply P rises from 20 to 30 ( $Δ P = + 10$ ). Q rises from 200 to 800 ( $Δ Q = + 600$ ). $E_{s} = (\frac{Δ Q}{Δ P}) \times (\frac{P _{1}}{Q _{1}}) = (\frac{600}{10}) \times (\frac{20}{200}) = 60 \times \frac{1}{10} =$ $+ 6$ . Comment: Since $E_{s} > 1$ , the supply is highly Elastic.

Q2Managerial Economics & Financial Accounting

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