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ASSINGMENT:
SOLUTION:
Let us assume that a wholesaler of biscuits knows that the price elasticity of
demand for biscuits remains unchanged at -1.5. The price of the biscuit increases
by 20%. We can determine the decrease in quantity demanded due to the
increase in price.
An increase in real income increases the demand for products, other factors
remaining the same. Income elasticity of demand for a product is the
percentage change in demand for that product divided by the
percentage change in the consumer’s income (d Y). The income elasticity
of demand of a product X can be mathematically denoted as:
= (dQX/QX) / (dY/Y)
= (dQX* Y) / (dY/QX)
Products and services with income elasticity above one are called Income
Elastic. For example, air travel, restaurant meals, movies, and other
entertainment are services on which people spend a lot with an increase in
income. Products and services with income Elasticity between zero and one
are called inelastic goods. For example, in developed countries like the US,
clothing, alcoholic beverages, and newspapers are examples of products for
which a rise in income generates little additional consumption. The demand for
certain products and services reduces when there is an increase in income.
These are known as inferior products having negative income elasticity.
Examples of inferior products are low-end brands of household products and
coarse cereals.
Sujeet Kumar | MBA 1st Semester
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Let us assume that the quantity demanded for two products X and Y are Q1 and
Q2 and they are priced at P1 and p2 respectively. The cross elasticity of demand
of product X is the percentage change in the quantity demanded due to the
percentage change in price.
This can be mathematically denoted as:
SOLUTION:
A. What are the factors which determine the ‘Price Elasticity’ of a product?
SOLUTION:
• Availability of Substitutes:
Demand for those commodities which have substitutes (for example, tea has
its substitute in coffee, orange juice has its substitute in lime juice) are
relatively more elastic. The reason being that when the price of commodity
falls in relation to its substitute, the consumers will go in for it and so its demand
will increase. Commodities having no substitutes like cigarettes, liquor, etc.
have inelastic demand.
• Income of consumer:
Sujeet Kumar | MBA 1st Semester
Roll No 25
Page |7
People whose income is very high or very low, their demand will ordinarily be
inelastic. Because rise or fall in price will have little effect on their demand.
Conversely, middle income groups will have elastic demand.
• Habits of consumer:
Goods to which a person becomes accustomed or habitual will have inelastic
demand like cigarette, coffee, tobacco, etc. It is so, because a person cannot do
without them.
• Price level:
Elasticity of demand also depends upon the level of price the concerned
commodity. Elasticity of demand will be high at higher level of price of the
commodity and low at the lower level of the price.
• Time period:
Demand is inelastic in short period but elastic in long period. It is so
because in long-run, a consumer can change his habits more conveniently than
in the short period.