Question

1. Acer faces demand for its laptops characterized by the following elasticities:

• Own-price elasticity = -1
• Cross-price elasticity with the operating system = -5
• Income Elasticity = 1.5

Respond to each of the following statements with True or False and an explanation. Use mathematical analysis and/or graphs where helpful.

a. A price reduction for laptops will increase both the number of units sold and the revenue of Acer.

b. The cross-price elasticity indicates that a 5% reduction in the price of windows will cause a 20% increase in demand for Acer laptops.

c. Acer's laptops are inferior goods.

d. Increasing prices for operating systems will decrease revenues for Acer.

e. A 2% price reduction by Acer would be necessary to overcome a 1% decline in income.

Answer 1

1. A) Acer's own price elasticity is -1. Or, it's absolute value of elasticity is 1, which means Acer has an unitary elastic demand for it's laptops. Demand is Unitary elastic when change in price leads to equal change in quantity demanded. So, a price reduction for laptops in this case will increase the no. Of quantity sold (or, quantity demanded) but as the reduction in price is equal to increase in units sold, so Total revenue remains constant.

Demand curve in this case is rectangular hyperbola and has an equation PQ = K, where P is the price, Q is the quantity and K is a constant term. So, any change in P will be matched by Q so that PQ (total revenue) remains unchanged.

Therefore, the given statement is False.

B) cross price elasticity of demand = % Change in quantity demanded for product A / % change in price of product B

If % change in the price of windows = -5 and % change in quantity demanded for Acer laptop = 20, then cross price elasticity of demand = 20/-5 = -4.

But it is given that, cross price elasticity of demand for Acer laptop is -5. So, the given statement is False.

C) An inferior good is associated with negative income elasticity of demand because in case of inferior good, when income increases that leads to decrease in the quantity demanded. But, it is given that income elasticity of Acer laptop is 1.5 which is a positive value. It means Acer laptop is normal good and not an inferior one.

So, the given statement is False.

D) operating system and Acer laptops are complementary of each other, that is, both are used together. Increase in price for Operating system will decrease the quantity demanded for it. Therefore, it will also decrease the quantity demanded for Acer laptops (as these two are complementary good), shifting the demand curve in Acer laptop market leftward. It will decrease both equilibrium price and quantity, and therefore total revenue for Acer will decrease.

so, the given statement is TRUE.