3.
Suppose that the demand for Abay Car (QA) is estimated to be
QA = 150 – 9PA – 5PG + 10M + 0.5PTWhere QA is demand for Abay Car, PA is price of Abay car,
PG is price of gasoline, M is
consumer income and PT is Price of Toyota Car. If PA = 10, PG = 10, M = 50 and PT = 180,
then determine
a) Own Price elasticity of demand, and interpret the result
b) Income elasticity of demand, and interpret the result
c) Cross price elasticity of demand between quantity demand for Abay Car and price of
Gasoline, and interpret the result
Answer:
The demand equation for Abay Cars is:
Qₐ = 150 − 9Pₐ − 5P₉ + 10M + 0.5Pₜ
Where:
● Qₐ is the number of Abay Cars demanded.
● Pₐ stands for the price of an Abay Car.
● P₉ is the price of gasoline.
● M is the buyer’s income.
● Pₜ is the price of a Toyota Car.
In the problem, the values are:
Pₐ = 10, P₉ = 10, M = 50, Pₜ = 180.
Calculating Qₐ:
Plugging these numbers into the formula:
Qₐ = 150 − 9(10) − 5(10) + 10(50) + 0.5(180)
Simplifying:
Qₐ = 150 − 90 − 50 + 500 + 90
So:
Qₐ = (150 − 140) + 590 = 600
So the demand for Abay Cars, based on this setup, comes out to be 600 units.
a) Own Price Elasticity of Demand
First, let’s recall the formula:
Elasticity = (change in Q with respect to price) × (price / quantity)
In this problem, the coefficient for Pₐ is -9, meaning for every one-unit increase in price, the
demand would drop by 9 cars.
Now applying the formula:
Elasticity = (-9) × (10 / 600)
Simplifying:
Elasticity ≈ -0.15
Interpretation:
This value shows that demand is inelastic. In plain terms, price changes don’t make a huge
difference — a 1% increase in price only reduces demand by about 0.15%. So buyers are not
very reactive to price changes.
b) Income Elasticity of Demand
For income elasticity, the formula is:
Elasticity = (change in Q with respect to income) × (income / quantity)
The income coefficient in the equation is 10. Plugging the numbers:
Elasticity = 10 × (50 / 600)
Simplifying:
Elasticity ≈ 0.833
Interpretation:
This tells us Abay Cars are a normal good, because the value is positive. But since it’s less than
1, the demand increases at a slower rate than income. For example, if people earn 1% more, the
demand for Abay Cars would rise by about 0.83%.