Answer to Question #172223 in Microeconomics for reem

Question

Answer the following questions using the concept of elasticity:

a. Suppose a businessperson earns monthly revenue of Rs.500,000 by selling 500 school bags at Price 1000 per bag. The owner is thinking to raise its price of school bag to Rs.1500 per bag to increase its revenue. How would this increase in price affect the revenue under following conditions?

  i.    Price elasticity of demand for bag is less than 1 (e <1)

  ii.   Price elasticity of demand for bag is greater than 1 (e >1)

 iii.  Price elasticity of demand for bag is equal to 1.

b. Determine the price elasticity of demand for good X if:

 i.    there is no close substitute of good X

 ii.   the good X is a luxury good

 iii.  the good X is an addictive good

Answer 1

Solution:

a.). i). When the price elasticity of demand for bag is less than 1 (e <1), it means the demand is inelastic. This means that increases in the price will lead to disproportionately small increases in quantity demanded. A percentage change in price leads to a smaller percentage change in demand.

ii). When the price elasticity of demand for bag is greater than 1 (e >1), it means the demand is elastic. This means that increases in the price will lead to disproportionately large increases in quantity demanded. A percentage change in price leads to a bigger percentage change in demand.

iii). When the price elasticity of demand for bag is equal to 1, it means the demand is unit elastic. This means that increases in the price will lead to proportionately equal increases in quantity demanded. A percentage change in demand is exactly the same as the percentage change in price.

 

b.). Determine the price elasticity of demand for good X if:

i). There is no close substitute of good X:

The price elasticity of demand for good X will be less than 1 and hence inelastic, since a percentage change in price will lead to a smaller change in quantity demanded. This is because there are no close substitutes for the good.

ii). The good X is a luxury good:

The price elasticity of demand for good X will be greater than 1 and hence elastic, since a percentage change in price will lead to a bigger percentage change in demand. This is because the good is not a necessity or required and hence can be eliminated.

iii). The good X is an addictive good:

The price elasticity of demand for good X will be less than 1 and hence inelastic, since a percentage change in price will lead to a smaller change in quantity demanded. This is because the good is addictive to its users who can leave without them. They have to buy the product no matter the cost.