Question 1:

Suppose the income elasticity of demand for furniture is +4.0 and the income elasticity of
demand for doctors services is + 0.4. Compare the impact on furniture and doctors services of
a recession that reduces consumer income by 10 per cent.
Furniture is a normal good and income elastic since Y = + 4.0, which is > 1.0;
(3 mars!
"octor#s ser$ices is a normal good and income inelastic since Y = + 0.4, which is % 1.0;
(3 mars!
&he im'act on (urniture is greater than that o( doctor#s ser$ices as (urniture as (urniture
would )e considered a lu*ur+ good, whereas doctor#s ser$ices are still considered a
necessit+ e$en during a recession.
(4 mars!
Question 2:
a! "nterpret the follo#in$ "ncome %lasticities of &emand '%&! values for the follo#in$
and state if the $ood is normal or inferior(
'%&) +0.*
&he demand res'onse as income changes (i.e. the 'ro'ortionate change in demand
di$ided )+ the 'ro'ortionate change in income!;
,nelastic )ecause % 1.0;
-ormal good )ecause the demand increases with income as indicated )+ the 'ositi$e
sign. (../ mars!
'%&) +2.*
&he demand res'onse as income changes (i.e. the 'ro'ortionate change in demand
di$ided )+ the 'ro'ortionate change in income!;
0lastic )ecause > 1.0;
,n(erior good )ecause the demand decreases with income as indicated )+ the
negati$e sign. (../ mars!
b! "nterpret the follo#in$ Cross+,rice %lasticities of &emand -%&! and state if the $oods
are substitutes or compliments.
-%&) + 0..
&he demand res'onse o( this good as the 'rice o( the other good changes (i.e. the
'ro'ortionate change in demand di$ided )+ the 'ro'ortionate change in 'rice o( the
other good!;
,nelastic )ecause the real a)solute $alue is % 1.0;
1u)stitute good )ecause the demand increases as the 'rice o( the other good
increases. (../ mars!
-%&) +2.2
&he demand res'onse as income changes (i.e. the 'ro'ortionate change in demand
di$ided )+ the 'ro'ortionate change in income!;
0lastic )ecause the real a)solute $alue is > 1.0;
2om'lementar+ good )ecause the demand (or the good decreases as the 'rice o( the
other good increases. (../ mars!
3usiness 4icroeconomics 35026 1/078
9e$ision :uestions ; 2ross <rice and ,ncome 0lasticit+ o( "emand8
=uthor ; <aul 4c<hee and "a$id 1'iers (2ourse 2oordinator > ?ecturer and ?ecturer
res'ecti$el+!

/ssume that portable ear phone model ,%010 is sold by 1ain$s electrical and your business
sells the 2,0 player that uses these ear phones.
3nfortunately4 you have had to increase the price of the 2,0 players from 5.* to 56* and as a
result4 the 7uantity demanded for the portable ear phones has decreased from 200 to 180.
/t a latter sta$e your sales staff tell you that the price of 1ain$s portable ear phones has
increased from 51* to 520 per set and as a result the 2,0 player demand has fallen from 2*0 to
20*.
a! Calculate the cross+price elasticity of demand for the ear phones4 and is it elastic or
inelastic9
<ro'ortionate change in ear 'hone demand > <ro'ortionate change in 4<3 'la+er
'rice
= @(1A0 ; .30! > .30B > @(7/ ; C/! > C/B = D 0.173A13043 > 0.1/3E4C1/3 = D1.13;
&his is > D 1.00 and there(ore elastic;
b! Calculate the cross+price elasticity of demand for the 2,0 players4 and is it elastic or
inelastic9
<ro'ortionate change in 4<3 demand > <ro'ortionate change in 'orta)le ear 'hone
'rice
= @(.0/ ; ./0! > ./0B > @(.0 ; 1/! > 1/B = D 0.1E > 0.33 = D0.//;
&his is % D 1.00 and there(ore inelastic.
c! "nterpret the values calculated in a! and b! i.e. are the :
3oth crossD'rice elasticit+ o( demand $alues are negati$e meaning that this 'air o(
goods are com'lements.
,( the sign o( the crossD'rice elasticit+ o( demand coe((icient is 'ositi$e the 'air o(
goods are su)stitutes. &he )igger the 'ositi$e coe((icient, then the more the+ are
su)stitutes. ,( the sign o( the crossD'rice elasticit+ coe((icients are Fero then there is
no relationshi' )etween the goods.
d! /re these cross price elasticities elastic or inelastic measures9
For 'orta)le ear 'hones it is elastic )ecause it is greater than D1.00 which means that
+ou get a more than 'ro'ortionate change (decrease! in the demand (or 'orta)le ear
'hones in res'onse to the 'ro'ortionate increase in the 'rice o( the 4<3 'la+ers.
For 4<3 'la+ers it is inelastic )ecause it is % D0.// which means that +ou get a less
than 'ro'ortionate change (decrease! in the demand (or 'orta)le ear 'hones in
res'onse to the 'ro'ortionate increase in the 'rice o( the 4<3 'la+ers.
e! /ssumin$ that a 10: increase in income #ill cause a *: increase in sales of 2,0
players4 #hat is the income elasticity of demand for the 2,0 players and is this $ood a
necessity or lu;ury $ood9
<ro'ortionate increase in 4<3 'la+er demand > <ro'ortionate increase in income =
(/G > 10G! = 0./;
&his income elasticit+ o( demand is inelastic (i.e. % 1.0!
f! "s this income elasticity of demand elastic or inelastic and interpret its value9
,nelastic )ecause it is less than 1.00 and this means that there is a less than
'ro'ortionate increase in 4<3 'la+er demand (or the 'ro'ortionate income
increase.
,( the sign is 'ositi$e and the $alue is % 1.0 )ut greater than Fero the good is a
normal good and is a necessit+. &his means that it has a downward slo'ing demand
cur$e and is not a lu*ur+ item. ,( the coe((icient is > 1.0 the good is a normal good
and also a lu*ur+ good.
,( the $alue is negati$e then the good is an in(erior good meaning that its demand
decreases with an increase in income. ,n this case it is liel+ to )e re'laced )+ a
)etter Hualit+ good.
$! <o# #ill the above 10: increase in income affect portable ear phone sales commencin$
#ith an initial e7uilibrium 7uantity demanded of 2009
From Huestion (e! we ha$e calculated that a 10 'er cent income increase will cause a
/ 'er cent increase in the demand (or 4<3 'la+ers. ,( we assume that there is one
set o( ear 'hones onl+ (or e$er+ 4<3 'la+er the sale o( 'orta)le ear 'hones will
increase )+ / 'er cent ((rom .30 to .4. rounded!.
h! <o# #ill the 10: increase in income affect the price of the 2,0 players9
Ie now (rom ((! that a 10G increase in income causes a /G increase in demand
(or ear 'hones (rom .30 'lus 11./ = to .4. rounded;
Ie now (rom (a! that the cross 'rice elasticit+ o( demand is D1.13;
Jence,
D1.13 = ('ro'ortionate change in ear 'hone demand > 'ro'ortionate change in 4<3
'la+er 'rice!;
so that D1.13 = (/G > KG!
Jence KG = (/G > D1.13! = D4.4.477E7C1 = D4.4., or a (all in the 'rice o( 4<3
'la+ers )+ 4.4.G ((rom LC/.00 to LC..13 rounded!.