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- 1. Law of Demand Other things equal, the quantity demanded of a good falls when the price of good rises . Elasticity A measure of the responsiveness of quantity demanded or quantity supplied to one of its determinants. Price Elasticity of Demand A measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percentage change in quantity demanded divided by the percentage change in price.
- 2. Question Suppose that your demand schedule for compact discs is as follows: Price QUANTITY DEMANDED QUANTITY DEMANDED $ (INCOME = $10,000) (INCOME = $12,000) 8 40 50 10 32 45 12 24 30 14 16 20 16 8 12
- 3. a. Use the midpoint method to calculate your price elasticity of demand as the price of compact discs increases from $8 to $10 if (i) your income is $10000 and (ii) your income is $ 12000. b. Calculate your income elasticity of demand as your income increases from $10,000 to $12000 if (i) the price is $12 (ii) the price is $16.
- 4. Solution a(i). The price of compact discs increase from $8 to $10, (i) if our income is $10,000; According to the midpoint method, (Q2 - Q1)/[( Q2 + Q1)/2] Price elasticity of demand = (P2 - P1)/[( P2 + P1)/2] P1 = 8 P2 = 10 Q1 = 40 Q2 = 32 Price QUANTITY DEMANDED QUANTITY DEMANDED $ (INCOME = $10,000) (INCOME = $12,000) 8 40 50 10 32 45
- 5. So, (32 -40)/ [ (32+ 40/2] Price elasticity of demand = (10 - 8)/[( 10 + 8)/2] -8/ 72/2 Price elasticity of demand = -8/36 = 2/18/2 -2/9 = 2/9 2/9 Price elasticity of demand = -1 Our price elasticity of demand is equal 1 So, our price elasticity of demand is unit elastic demand.
- 6. Price P1 = 8 , Q1 = 40 – total revenue = p1 x Q1 = 8x40 = 320 P2= 10,Q2 = 32 – total revenue = P2 x Q2 = 10x32 = 320 -in unit elastic demand(Ed=1) , a change in the price does not affect total revenue. p2 p1 Demand curve q2 q1 Quantity
- 7. a(ii). The price of compact discs increase from $8 to $10, (ii) if our income is $12,000; According to the midpoint method, (Q2 - Q1)/[( Q2 + Q1)/2] Price elasticity of demand = (P2 - P1)/[( P2 + P1)/2] P1 = P2 = 8 10 Q1 = 50 Q2 = 45 Price QUANTITY DEMANDED QUANTITY DEMANDED $ (INCOME = $10,000) (INCOME = $12,000) 8 40 50 10 32 45
- 8. So, (45 -50)/ ( 45+ 50/2] Price elasticity of demand = (10 - 8)/[( 10 + 8)/2] -5/ 95/2 Price elasticity of demand = -5x 2/95 = 2/18/2 -2/19 = 2/9 2/9 2 = 19 9 x 2 Price elasticity of demand = 9/19 = 0.47 Our price elasticity of demand is smaller than 1 So, Our price elasticity of demand is inelastic demand.
- 9. Price P1 = 8 , Q1 = 50 – total revenue = p1 x Q1 = 8x50 = 400 P2= 10,Q2 = 45 – total revenue = P2 x Q2 = 10x32 = 450 -in inelastic demand (Ed < 1) , a price increase rises total revenue and a price decrease reduces total revenue. p2 p1 Demand curve q2 q1 Quantity
- 10. b. Calculate your income elasticity of demand as your income increases from $10,000 to $12000 if (i) the price is $12 (ii) the price is $16. Our income elasticity of demand is as our income increases from $ 10,000 to $ 12000 if (i) the price is $ 12 According to the equation i. Percentage change in quantity demanded Income elasticity of demanded = Percentage change in income Price QUANTITY DEMANDED QUANTITY DEMANDED $ (INCOME = $10,000) (INCOME = $12,000) 12 24 30
- 11. Point A: Income = 10,000 Point B: Income = 12,000 Quantity Demanded = 24 Quantity Demanded = 30 Going to Point A to Point B, the income rises by 20 percent because 12000-10000/10000 x 100 = 20 and the quantity demanded also rise 25 percent because 30-24/24 x 100 = 25 25 Income elasticity of demanded = 5 = 20 = 1.25 4 As our income increases from $ 10,000 to $ 12000 if (i) the price is $ 12 , our income elasticity of demand is 1.25 and so it is positive income elasticity and we conclude that is normal good.
- 12. ii. Our income elasticity of demand is as our income increases from $ 10,000 to $ 12000 if (ii) the price is $ 16 According to the equation Percentage change in quantity demanded Income elasticity of demanded = Percentage change in income Price QUANTITY DEMANDED QUANTITY DEMANDED $ (INCOME = $10,000) (INCOME = $12,000) 16 8 12
- 13. Point A: Point B: Income = 10,000 Income = 12,000 Quantity Demanded = 8 Quantity Demanded = 12 Going to Point A to Point B, the income rises by 20 percent because 12000-10000/10000 x 100 = 20 and the quantity demanded also rise 50 percent because 12-8/12 x 100 = 33 50 Income elasticity of demanded = 10 = 20 = 2.5 4 As our income increases from $ 10,000 to $ 12000 if (ii) the price is $ 16 , our income elasticity of demand is 2.5 and so it is positive income elasticity and we conclude that is normal good.

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