Answer to Question #222409 in Macroeconomics for dasa

Question

You are the manager of a firm that receive revenue of Rs.30,000 per year from product 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 you firm’s total revenue (revenues from both products) change if you increase the price of good X by 1 present?

Answer 1

1% increase in price of good X implies that there will be a decrease in demand and a subsequent fall in total revenue for good X by the same proportion.

Cross elasticity being 1.1 means that good X and good Y are substitutes . So, as a result of fall in demand of good X due to increase in price, demand for good Y will rise.

Cross elasticity of demand is given by percentage change in in demand for good Y divided by percentage change in price for good X. In this case, demand for good Y increases and also price for good Y increases by 1%. Both the numerator and the denominator show positive increases.

Total revenue generated from good Y will increase by the same proportion as the fall in demand for good X.