Question

You are the manager of a firm that receives revenue of Rs.30,000 per year from products X and Rs. 70,000 per year from product Y. The own-price elasticity of demand for product X is -2.5 and the cross-price elasticity of demand between product Y and X is 1.1. How much will your firm’s total revenue (revenues from both products) change if you increase the price of good X by 1 present?

Answer 1

It is given that the own-price elasticity if -2.5, it implies that a 1% change rise in the price level will decrease the demand for product X by 2.5%.

Therefore, revenue loss on product X would be:

$=Rs.30,000×(−2.5)\\ =−Rs750$

Similarly, cross-price elasticity of demand is given as 1.1; it implies that the 1%incarese in the price of product X will lead to an increase in the demand for product Y would be 1.1

Therefore, revenue gain on product Y would be:

$=Rs.70,000×(1.1)\\ =Rs770$

Using the change in the revenue of both the products, the firm’s total revenue would be:

$=(−Rs. 750)+(Rs. 770)\\ =Rs. 20$

Hence, 1% change in the price of product X leads to increase in the total revenue of the firm by Rs. 20.