problem 2

1.
An analyst for a major apparel company estimates that the demand for its raincoats (x) is
given by ln Qxd = 10 − 1.2 ln Px + 3 ln R − 2 ln Ay where R denotes the daily
amount of rainfall and Ay represents the level of advertising on good Y. Can you think of a
good that might be good Y in this example? What would be the impact on demand of a 10
percent increase in the daily amount of rainfall? What would be the impact of a 1 percent
reduction in the amount of advertising directed toward good Y? Umbrella. Increase by 30%;
increase by 20%;
2. Answer the following questions based on the accompanying diagram.
a. How much would the firm’s revenue change if the price fell from $12 to $10? Is
demand elastic or inelastic in this range? Revenue at $12 is $12, at $10, it is $20.
Revenue increases by $8. Demand is elastic.
b. How much would the firm’s revenue change if the price fell from $4 to $2? Is
demand elastic or inelastic in this range? At $4, revenue is $20, at $2, revenue is
$12. Revenue decreases by $8. Demand is inelastic.
c. What price maximizes the firm’s total revenue? What is the elasticity of demand at
this point on the demand curve? Total revenue is maximized at point (3.5, 7) and
elasticity is -1.
3. The demand curve for a product is estimated to be Qxd = 1200 – 3Px – 0.1 Pz, where Pz =
$300.
a. What is the own price elasticity of demand when Px = $140? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price below $140? -0.56, inelastic, revenue will increase.
b. What is the own price elasticity of demand when Px = $240? Is demand elastic or
inelastic at this price? What would happen to the firm’s revenue if it decided to
charge a price above $240? -1.6, elastic, revenue will decrease.
c. What is the cross-price elasticity of demand between good X and good Z when Px =
$140? Are good X & Z substitutes or complements? -0.04, complements.
4. Suppose the estimated demand for a firm’s product is given by
ln Qxd = 7 – 1.5 lnPx + 2 lnPy – 0.5 lnM + ln A
where Px = $15; Py = $6; M = $40,000; A = $350
a. Determine the own price elasticity of demand and state whether demand is elastic,
inelastic or unitary elastic. -1.5, elastic.
b. Determine the cross-price elasticity of demand between good X and good Y, and
state whether these goods are substitutes or complements. +2, substitutes
c. Determine the income elasticity of demand and state whether good X is a normal or
inferior good. -0.5, inferior
d. Determine the own advertising elasticity of demand. 1.
5. Suppose the own price elasticity of demand for good X is -5, its income elasticity is -1, its
advertising elasticity is 4, and the cross-price elasticity of demand between it and good Y is 3.
Determine how much the consumption of X will change if
a. The price of good X decreases by 6 percent. +30%
b. The price of good Y increases by 7 percent. +21%
c. Advertising decreases by 2 percent. -8%
d. Income increases by 3 percent. -3%
6. Suppose the cross-price elasticity of demand between goods X and Y is 2. How much would
the price of good Y have to change in order to increase the consumption of good X by 50
percent? +25%
7. A firm receives revenues of $20000 per year from product X and $80,000 per year from
product Y. The own price elasticity of demand for product X is -3 and the cross-price
elasticity of demand between products Y and X is -1.6. How much will the firm’s total
revenues (from both the products) change if the price of good X increases by 2 percent?
Total revenue, R = P x Q; therefore, dR =P dQ + Q dP = PQ ( dQQ + dPP )

Or
R (
d R dQ dP
= +
Q P ) since R = PQ
dP dQ dP
Now = 0.02; for commodity X, =e p × =−3 × 0.02=−0.06 = - 6%
P Q P
Therefore, there will be a drop in the revenue from good X by $1200.
d QY d PX
Similarly, for commodity Y, =e XY × =−1.6 × 0.02=−0.032=3.2%
QY PX
Therefore, there will be a drop in the revenue from good Y by $2560.
Total drop is $3760

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Total revenue, R = P x Q; therefore, dR =P dQ + Q dP = PQ ( dQQ + dPP )

Total drop is $3760

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