1. Answer the following questions based on the accompanying diagram. a.

How much would the firm s revenue change if it lowered price from $12 to $10? Is demand elastic or inelastic in this range? When price is $12, Revenue = Demand X Price = 1 X $12 = $12

When price is $10, Revenue = Demand X Price = 2 X $10 = $20

The change in revenue is $8. Price elasticity of demand= % change in quantity /% change in price = 50% / -17% = - 2.94 The value of -2.94 means that when price decrease, demand will increase and vice versa. This shows that demand of the product is inelastic.

b. How much would the firm s revenue change if it lowered price from $4 to $2? Is demand elastic or inelastic in this range? When price is $4, Revenue = Demand X Price = 5 X $4 = $20

When price is $2, Revenue = Demand X Price = 6 X $2 = $12

The change in revenue is $-8. Price elasticity of demand= % change in quantity /% change in price = 20% / -50% = - 0.4 The value of -0.4 means that when price decrease, demand will increase and vice versa. This shows that demand of the product is inelastic. c. What price maximizes the firm s total revenues? What is the elasticity of demand at this point on the demand curve? Firm s revenue is maximized when price is between $6 and $8. When price is $6, Revenue = Demand X Price = 4 X $6 = $24

When price is $8, Revenue = Demand X Price = 3 X $8 = $24

The change in revenue is $0. Price elasticity of demand= % change in quantity /% change in price = -25% / 33% = - 0.75 The value of -0.75 is less than 1. This shows that demand of the product is inelastic. 2. The demand curve for a product is given by Qdx = 1000 2Px + .02Pz, where Pz = $400. a. What is the own price elasticity of demand when Px = $154? Is demand elastic or inelastic at this price? What would happen to the firm s revenue if it decided to charge a price below $154? Qdx = 1000 2(154) + .02(400) = 1000 308 + 8 = 700 = 1000 2(153) + .02(400) = 1000 306 +8 = 702 = % change in Quantity / % change in Price = 0.3% / - 0.6% = - 0.44

Qdx1

Price elasticity of demand

The value of -0.44 means that when price increase, demand will decrease and vice versa. This shows that demand of the product is inelastic. Revenue = Demand X Px = 700 X 154 = $107,800.00 = 702 X 153 = $107,406.00

Revenue

As a conclusion, if the firm decides to reduce the price of good X to $153, the firm s revenue will decrease by $394.

b. What is the own price elasticity of demand when Px = $354? Is demand elastic or inelastic at this price? What would happen to the firm s revenue if it decided to charge a price above $354? Qdx = 1000 2(354) + .02(400) = 1000 708 + 8 = 300 = % change in Quantity / % change in Price = -57% / 230% = - 0.25

Price elasticity of demand

The value of 0.25 means that when price increase, demand will decrease and vice versa. This shows that demand of the product is inelastic. Qdx1 = 1000 2(355) + .02(400) = 1000 710 + 8 = 298 = Demand X Px = 300 X 354 = $106,200.00 = 298 X 355 = $105,790.00

Revenue

Revenue

As a conclusion, if the firm decides to increase the price of good X to $355, the firm s revenue will decrease by $410. c. What is the cross-price elasticity of demand between good X and good Z when Px = $154? Are goods X and Z substitutes or complements? Let Pz = $399 Qdx = 1000 2(154) + .02(399) = 1000 308 + 7.98 = 699.98

Cross-price elasticity of demand = % change in quantity X / % change in price of Z = - 0.0029% / -0.3% = 0.01

Above shows that when price of Good Z decrease, the demand for Good X will also decrease. The value of cross-price elasticity is positive; therefore Good X and Good Z are substitutes. 4. Suppose the own price elasticity of demand for good X is -2, its income elasticity is 3, its advertising elasticity is 4, and the cross-price elasticity of demand between it and good Y is -6. Determine how much the consumption of this good will change if: Price elasticity of demand= % change in quantity /% change in price Income elasticity of demand = % change in quantity / % change in income Advertising elasticity of demand = % change in quantity / % change in advertising Cross-price elasticity of demand = % change in quantity X / % change in price of Y a. The price of good X increases by 5 percent = -2 X 5% =- 0.1 b. The price of good Y increases by 10 percent = -6 X 10% = - 0.6 c. Advertising decreases by 2 percent = 4 X -2% = -0.8 d. Income falls by 3 percent. =3 X -3% = -0.9

5. Suppose the cross-price elasticity of demand between goods X and Y is -5. How much would the price of good Y have to change in order to increase the consumption of good X by 50 percent? Cross-price elasticity of demand = % change in quantity X / % change in price of Y -5 = 50 % / Y% Y% = 50% / -5% = -10% From the above, we conclude that price of good Y needs to decrease by 10% in order for consumption of good X to increase by 50%. 14. If Starbucks s marketing department estimates the income elasticity of demand for its coffee to be 1.75, how will looming fears of a recession (expected to decrease consumer s incomes by 4 percent over the next year) impact the quantity of coffee Starbucks expects to sell?

Income elasticity of demand = % change in quantity / % change in income Where income elasticity of demand= 1.75 % change in quantity = ? % change in income = -4%

% Change in quantity

= Income elasticity of demand X % change in income = 1.75 X -4% = -7.0%

As a conclusion, when income reduces by -4%, the demand will decrease by about -7%.