NAME: NEEHA HASSAN

ASSIGNMENT 3 A

1. The price elasticity of demand for chicken is estimated to be – 0.65. If the price of chicken
increased by 6 percent, what will be the expected percentage decrease in the quantity of chicken
sold?

FORMULA: %Q/ %  P = Ep

where Ep is price elasticity, %Q is change in quantity demanded, %  P change in Price

SOLUTION

Ep (%P) = -0.65(0.06) = -3.9% ANSWER

The expected percentage decrease in the quantity of chicken sold is -3.9 % and the demand is
elastic.

2. The average price for personal computers has recently decreased from Rs.300 to Rs.250. As a
result, the quantity of personal computers bought has increased by 20 percent. What would be
the price elasticity of demand for personal computers?

FORMULA: %Q/ %  P = Ep ie {Q2 – Q1/ ( Q2 + Q1 /2)} / P2 – P1/ ( P2 + P1 /2)}

SOLUTION

%P = (250-300)/((250+300)/2) = -18.18 %

%Q = 20 %

= 20/ -18.18
= - 1.10 ANSWER

The price elasticity of demand for personal computers is - 1.10 where the demand is elastic.

3. The demand for Shell Oil motor oil can be characterized by the following point elasticities:
price elasticity = -2.5, cross-price elasticity with Total motor oil = 1.5, and income elasticity =
0.75. Indicate
whether each of the following statements is true or false, and explain your answer.
a. A price increase for Shell’s Oil will decrease both the number of units demanded and the total
revenue of sellers.
b. The cross-price elasticity indicates that a 2% increase in the price of Total oil will cause a 3%
increase in Shell Oil demand.
c. Demand for Shell Oil is price elastic and the motor oil is a cyclical, normal good. Falling Total
oil prices will increase revenues received by manufacturers of both brands
of oil.
e. A 0.9% price reduction for Penn's Oil would be necessary to overcome the effects of a 3%
decline in income.

SOLUTION

a) True. A price increase will always decrease units sold, given a downward sloping
demand curve due to negative sign. Since the price elasticity equals -2.5 indicates that demand
is elastic with respect to price, and therefore a price increase will also decrease total revenues.

b) SOLUTION :

Cross price elasticity of Demand: = % P of good y.

Cross price elasticity = 1.5 and % increase in the price of Y = 2%

= > 1.5= % Q of good x / 2% = 3 %

TRUE The cross price elasticity of demand is an economic phenomena that measures
responsiveness of quantity demanded of 1 good when the price of another good changes. The
positive cross-price elasticity indicates that a 2% increase in the price of the substitute good
(Total oil) will have the effect of increasing Shell Oil demand.
demand by 3%.

c) False. Demand is price elastic (greater than 1) increase in price will have effect on quantity
demanded and Shell’s Oil is a normal good. However, because the income elasticity is less than
one, Motor oil is a normal good and not a superior good. When income elasticity is greater than
one we call the good as cyclical good.

d) False. A positive cross-price elasticity indicates that the two motor oils are substitutes.
Therefore, falling Total oil prices will decrease the demand for shell’s Oil and resulting
revenues for its manufacturers. However, there is no information concerning the price
elasticity of demand for Total oil and therefore do not know the effect of falling prices on its
revenues.

(e)

FORMULA

EP = {Q2 – Q1/ (Q2 + Q1 /2)} / P2 – P1/ ( P2 + P1 /2)}

SOLUTION

Price elasticity = - 2.5 %

%  P = 0.9 %
So,

-2.5 = %  Q / 0.9
Or
0.9 (-2.5) = %  Q
= -2.25 increase in quantity demanded

True. A 0.9% reduction in price will cause a 2.25% increase in the quantity of Penn's Oil
demanded. A 3% decline in income will cause a 2.25% fall in demand. These changes will be
mutually offsetting.

4. Given the demand for bicycles in Pakistan Q = 2000 + 15Y – 5.5P, where Y is income in
thousands of Rupees, Q is quantity demanded in units, and P is price (Rs. per unit). When P is
150 Rs. and Y is 15,000 Rs., determine the following: (a) Price elasticity of demand. (b) income
elasticity of demand

FORMULA

1 ) EP = [%  Q / Q] / [ %P/ P] = Q2 – Q1/ Q1 / P2 – P1/ P1

or

%  Q / % P * Price 1 / Quantity 1

2 ) EP = [%  Q / Q] / [ %I / I]

SOLUTION

Substituting,

Q = 2000 + 15Y – 5.5P,

= 2000 + 15 (15) – 5.5 (150)
= 2000 +225 – 825
= 1400

a) Price elasticity of demand

(a) EP = (∂Q/∂P)(P/Q) = (-5.5)(150/1400) = -0.59 ANS

(b) EY = (∂Q/∂Y)(Y/Q) = (15)(15/1400) = 0.16 ANS
5. The manager of a supermarket accidentally miss-marked the price of 10-killo bag of rice at
Rs.4.38 instead of the regular price of Rs.5.18. At the end of a week, the store's inventory of 200
bags of rice was completely sold out. The store normally sells an average of 150 bags per week.
a. What is the store's point elasticity of demand for rice? b. Give an economic interpretation of
the numerical value obtained in part (a)

a ) FORMULA :

POINT ELASTICITY OF DEMAND : EP = {Q2 – Q1/ (Q2 + Q1 /2)} / P2 – P1/ ( P2 + P1 /2)}

SOLUTION

= [200 – 150 / 175 / 4.38 – 5.18 / 4.78]

= .2857/-.1673
= - 1.70

b) A mismarked price charged at the super market increased the demand of rice bags by 1.70% .
Demand is elastic as the value obtained is greater than 1. Similarly, a 1% increase in price will
result in a 1.70 % decrease in quantity demanded.

ASSIGNMENT 3 B

1. Rahat Corporation markets a compact microwave oven. This year they sold 23,000 units at
$375 each. Per capita disposable income this year was $6,750. Economists at Rahat Corporation
have determined that the arc price elasticity for this microwave oven is −1.2.
a. Next year Rahat is planning to lower the price of the microwave oven to $325. Forecast sales
volume for next year assuming that all other things remain equal.
b. However, in checking with government economists, Rahat finds that per capita disposable
income is expected to rise to $7,000 in 2007. In the past the company has observed an arc
income elasticity of +2.5 for microwave ovens. Forecast next year sales given that the price is
reduced to $325 and that per capita disposable income increases to $7,000. Assume that the price
and income effects are independent and additive.

a ) FORMULA :

ARC ELASTICITY OF DEMAND

Arc elasticity = {Q2 – Q1/ (Q2 + Q1 /2)} / P2 – P1/ ( P2 + P1 /2)}

or

= Q2 -Q1 / Q2+Q1 * P2+ P1 / P2-P1 ( 2 gets cancelled )

SOLUTION

a) Q1 = 23,000
 P1 = $375
P2 = $325
Q2 =?

Using substituting method

-1.2 = Q2 -Q1 / Q2+Q1 * P2+ P1 / P2-P1

-1.2 = Q2 – 23000 / Q2+23000 * 325+375/ 375-325

-1.2 = Q2 – 23000 / Q2+23000 * 700/-50

-1.2 = Q2 – 23000 / Q2+23000 * - 14 ( MULTIPLY DENOMENATOR AT THE OTHER SIDE)

-1.2 (Q2+23000) = Q2 – 23000 * -14

= - 27600 – 322000 = - 14 Q2 + 1.2 Q2

= -349600 = - 12.8 Q2 (DIVIDING ON BOTH SIDES)
Q 2= 27312.5 units

(b) Price effect:

FORMULA %Q = ED%P = E D x P2-P1/(P2+P1)/2

= −1.2 (325-375) / (325+375)/2

= 60/350

=0.1714 (=17.14%)

Income effect:

FORMULA %Q = EY%Y = E Y x Y2-Y1/(Y2+Y1)/2

Y2 = 7,000
Y1 = 6,750

= %Q= +2.5  (7,000 − 6,750) /(6,750 + 7,000) /2

= 625/6875
= .0909 (= 9.09%)

Net effect = Price effect + Income effect = .1714 + .0909 = .2623 (=26.23%)

Using the initial quantity (Q1 = 23,000) as the base in computing the percentage change
yields:
Q2 = Q1 (1 + Net effect) = 23,000 (1 + .2623) = 29,033 units

Using the average quantity [(Q1 + Q2)/2] as the base in computing the percentage change yields:
%Q = Q 2 − Q1 / (Q 2 + Q1 ) / 2

.262 = Q 2 − 23,000 / (Q 2 + 23,000) / 2

Q2 = 29,934 units

2. The LG corporation is considering lowering the price of its TV from $800 to $600. The LG
has estimated that the price elasticity of its TV to be -2 over this price range. Presently the LG
sells 1000 TV units per month.
a. What will be the new quantity sold if the price is lowered to $600?
b. What additional information does LG need to know before it can determine whether or not a
price decrease will increase the company's profit?
c. Suppose that after LG lowers its price, its competitor, Sony, lowers price of its TV from $900
to $800. The cross elasticity between the two firm's TVs is estimated to be +0.5. What will be the
effect of Sony's price decrease on the quantity sold by LG?

SOLUTION

a) FORMULA: -

Elasticity = Q2 -Q1 / Q2+Q1 * P2+ P1 / P2-P1 ( 2 gets cancelled )

= Q1 = 1000
= P2 = 600
= P1 = 800
= Q2 =?

Elasticity = Q2 -Q1 / Q2+Q1 * P2+ P1 / P2-P1

=> -2 = Q2- 1000 / Q2 + 1000 * 600+800/ 600- 800

=> -2 = Q2- 1000 / Q2 + 1000 * 1400/-200

=> -2 = Q2- 1000 / Q2 + 1000 * - 7 ( MULTIPLY DENOMENATOR AT THE OTHER SIDE)

=> -2 ( Q2 + 1000 ) = - 7 * (Q2- 1000)

=>- 2Q2 + 2000 = - 7 Q2 + 7000

=>-2Q2 + 7 Q2 + 2000 + 7000 = 0

=> 5 Q2 – 9000 = 0

=> Q2 = 9000/5 (DIVIDING ON BOTH SIDES)

=> Q2 = 1800
(b) LG Will need to know information regarding Total cost to determine company's profit as a
result of price reduction. Profits cannot be determined unless costs are known i.e Total profit =
Total revenue – total cost.

C ) FORMULA: - Cross price elasticity of Demand = % P of good y.

SOLUTION

% decrease in the price of Sony tv = P2-P1/(P1+P2)/2 =

=> 800-900/ 800 + 900/2 = -100/850

= -0.117

Substitute is price elasticity formula :

= > 0.5= % Q of good (LG) / -0.117

= > % Q of good (LG) = 0.5 ( - 0.117)

= - 0.058 or - 5.88 %

Decrease in the price on Sony Tv will decline – 5.88 % quantity sold by LG . This will make
Q2 of LG as 1697

3. Kodak currently sells its camera at $90 and sells 200 cameras per month. A close competitor,
Olympic, has cut the price of a similar camera it makes from $100 to $80. Suppose the cross
elasticity of demand between the two cameras is 0.4.
a. What impact, if any, will the action by Olympic have on total revenue generated by Kodak, if
Kodak leaves its current price unchanged?
b. Now suppose that Kodak decided to sell the same quantity as it used to sell at $90. What
would be the new price if price elasticity of demand between $90 and the new price is -2?
c. Is the new price better for Kodak if its goal is to increase revenue? What if it wants to increase
profits?

FORMULA

Since the total revenue of Kodak = P * Q = 200 * 90 => 18000 Rs

We will now find / [ %P/ P] Olympic

= (80-100)/ (100+80/2)
= -20 / 90
= - 0.222
Cross elasticity of demand = (%  Q / Q] good a / [ %P/ P] good b

= > 0.4= %  Q / Q good a / - 0.222

=> 0.4 (- 0.222) = %  Q / Q Kodak
=> - 0.0888 or – 9 %

Total revenue generated by Kodak if Kodak leaves its current price unchanged, reduces by
approx. 9 % making it to reduce to 16, 380 Rs from 18000 Rs

B ) SOLUTION

= Q1 = 200
= Q2 = 200 (as same quantity was sold before and after the price change )
= P1 = 90
= Ed = -2
= P2 = ?

FORMULA

Elasticity = Q2 -Q1 / Q2+Q1 * P2+ P1 / P2-P1 ( 2 gets cancelled )

=> - 2 = 200 – 200 / (200 + 200 ) * (P2 + 90) / (P2 – 90)
=> - 2 = 0 / 400 * (P2 + 90) / (P2 – 90)
=> - 2 = 0 * (P2 + 90) / (P2 – 90)
=> - 2 (P2 – 90) = 0 * (P2 + 90)
=> - 2 (P2 – 90) = 0
=> - 2 P2 + 180 = 0
=> P2 = 180/2 = $90 Since the quantity did not change the price stayed unaffected with -2
elasticity.

(c) Good, since TR increases by $7,300, but profit is indeterminate since TC is not known.

4. Suppose that the price elasticity of demand for wheat is known to be -0.75. Will a good wheat
crop (which increases the supply of wheat) be likely to increase or decrease the revenues of farmers?
Carefully explain.

ANSWER

Wheat is a normal good and the increase in supply happens due to increase in the price of wheat . Also
, the price elasticity of demand is less than 1 therefore it is deemed as inelastic and price changes will
slightly decrease the revenue but won’t impact revenues of the farmers significantly as the percentage
change in demand will be less than the percentage change in price.
A good wheat crop that increases the supply of wheat will cause the equilibrium price of wheat to
decrease (and quantity to increase).
 5 The income elasticity for most staple foods, such as wheat, is known to be between zero and one.
a. As incomes rise over time, what will happen to the demand for wheat?
b. What will happen to the quantity of wheat purchased by consumers?
c. What will happen to the percentage of their budgets that consumers spend on wheat?
d. All other things equal, are farmers likely to be relatively better off or relatively worse off in periods
of rising incomes?

ANSWER

(a) Demand will increase, since wheat has a positive income elasticity and is a normal good
(b) The quantity of wheat purchased will increase.
(c) The percentage of consumer budgets spent on wheat and other staple goods will fall, since the
percentage change in the demand for wheat will be less than the percentage change in income.
(d) Farmers are likely to be relatively worse off, since the demand for what they are selling will be
rising less rapidly than the demand for other goods that they are likely to purchase.