ME Tutorial -6Q1. If Ali’s income increases from $36000 to $ 40000 and the amount of donuts he consumes increases from 52 per year to 86 per year . Calculate the income elasticity of Demand . What type of goods are donuts for Ali ?Q2. The price of tea increased from $1.20 to $1.50 per box . The quantity of scones demanded changed from 10 units to 8 units . Calculate Cross Elasticity of Demand and comment on the relationship between the two goodsQ3. Times Media has estimated the demand for its service to be given by the following function:

Q = 9.83P-1.2A2.5Y1.6P0-1.4

Q = monthly sales in units; P = price of the service in Rs; A = promotional expenditure in Rs’000

Y = average income of the market in Rs’000; P0 = price of ‘home movies’ in Rs

The current price of Times Media is Rs 60, promotional expenditure is Rs 120,000, average income is Rs 28,000, and the price of ‘home movies’ is Rs 45.Indicate whether the following statements are true or false, giving your reasons and making the necessary corrections.a.If Times Media increases its price this will

reduce the number of its customers.b. If Times Media increases its price

this will reduce its revenues.c.People’s expenditure on the cable TV

service as a proportion of their income will increase when their income increases.

d. If Times Media increases its price this will increase the sales of ‘home movies’.

e. ‘Home movies’ are a substitute for cable TV.

f. A 5% increase in income will increase demand by 16%.

g.A 10% increase in price will reduce demand by 12 %.

h. Current sales are over a million units a month.

ME Tutorial -6Q1. If Ali’s income increases from $36000 to $ 40000 and the amount of donuts he consumes increases from 52 per year to 86 per year . Calculate the income elasticity of Demand . What type of goods are donuts for Ali ?Q2. The price of tea increased from $1.20 to $1.50 per box . The quantity of scones demanded changed from 10 units to 8 units . Calculate Cross Elasticity of Demand and comment on the relationship between the two goodsQ3. Times Media has estimated the demand for its service to be given by the following function:

Q = 9.83P-1.2A2.5Y1.6P0-1.4

Q = monthly sales in units; P = price of the service in Rs; A = promotional expenditure in Rs’000

Y = average income of the market in Rs’000; P0 = price of ‘home movies’ in Rs

The current price of Times Media is Rs 60, promotional expenditure is Rs 120,000, average income is Rs 28,000, and the price of ‘home movies’ is Rs 45.Indicate whether the following statements are true or false, giving your reasons and making the necessary corrections.a. If Times Media increases its price this

will reduce the number of its customers.b. If Times Media increases its price this

will reduce its revenues.c. People’s expenditure on the cable TV

service as a proportion of their income will increase when their income increases.

d. If Times Media increases its price this will increase the sales of ‘home movies’.

e. ‘Home movies’ are a substitute for cable TV.

f. A 5% increase in income will increase demand by 16%.

g. A 10% increase in price will reduce demand by 12 %.

h. Current sales are over a million units a month.

Solutions

Ans 1 : Income Elasticity of Demand is 4.7 , Normal / Luxury Goods

Ans 2 : Cross Elasticity of demand is -1 , complementary goods

Ans 3 :

a) True; customers and quantity demanded are synonymous in this case, and there is an inverse relationship between Q and P (law of demand) and as seen by the negative price elasticity.

b) Important derivation below;

Consider a demand function, Q = aPb

Then,

Price elasticity of demand (PED) will be:

Now solution to the statement;

True; demand is elastic (using above derivation, PED in this case turns out to be 1.2 or -1.2, remember in case of PED negative sign is ignored always), since the PED is greater than 1 in absolute magnitude. Therefore, an increase in price causes a greater than proportional decrease in quantity demanded and a fall in revenue.

c) True; this is because the YED (Income elasticity of demand) is greater than 1 (using above derivation, YED in this case turns out to be 1.6), indicating that cable TV is a luxury product. Note that the statement would be false if the good were a staple. For staples, although expenditure on the product increases as income increases, expenditure as a proportion of income falls, since expenditure rises more slowly than income.

d) False; the two products are complementary, shown by the CED (Cross elasticity of demand; using above derivation, CED in this case turns out to be -1.4) being negative; therefore an increase in the price of one product will reduce the sales of the other. It appears therefore that ‘home movies’ is a cable channel.

e) False; the two products are complementary, shown by the CED being negative.

f) False; YED=1.6; therefore using the simple elasticity formula (reasonably accurate for small changes) the change in demand will be

g) True; change/reduction in demand will be

h) False; current sales are given by