Question

Cornerstone Exercise 2-20 Transaction Analysis Four transactions a

TOIVOTU ack to Assignment Attempts: Keep the Highest: /4 1. Determinants of the price elasticity of demand Consider some determinants of the price elasticity of demand: • The availability of close substitutes . Whether the good is a necessity or a luxury • How broadly you define the market • The time horizon being considered A good with many close substitutes is likely to have relatively substitutes if the price of the good rises. A good's price elasticity of demand depends in part on how necessary same, which one has the most elastic demand? O Diamond necklace

Answer 1

1. A good with many close substitutes is likely to have relatively elastic demand because buyers have the option to choose from the other substitutes available, when the price of the good increases. Price elasticity measures the degree of change in quantity demanded by the consumers due to change in price of the commodity. When the consumers change the quantity demanded drastically due to a small change in price, then the demand is said to be elastic. On the other hand, if the buyers alter their purchasing pattern very little due to a huge change in price, then it is known as inelastic demand. In this case, if the good has many close substitutes already available, then when the price of the commodity increases, the buyers will shift to the one of the close substitutes available in the market and demand less of the commodity, whose price has increased. Therefore the demand for the good with many close substitutes is relatively elastic.

2. Data collected from the economy of Royal City reveals that a 15% decrease in income leads to the following changes:

• A 9% increase in the quantity of spades demanded
• A 17% decrease in the quantity of horses demanded
• A 29% decrease in the quantity of diamonds demanded

Income elasticity of demand measures the responsiveness of the quantity demanded for a good due to change in income of the buyers who consume the good, assuming ceteris paribus.
The formula for calculating income elasticity is given by the percentage change in quantity demanded divided by the percentage change in income of the consumer. This helps us to determine whether the good is a normal or inferior good.

Good	Income elasticity of demand	Normal or Inferior good
Spades	= 9%/-15% = - 0.6	Inferior
Horses	= -17%/-15% = 1.13	Normal
Diamonds	= -29%/-15% = 1.93	Normal

Negative income elasticity explains inferior goods which implies that decrease in income of the consumer will lead to increase in the quantity of inferior good demanded. On the other hand, positive income elasticity refers to normal goods, where decrease in income of the consumer will lead to a fall in demand for the good.