Question

3. The Schmidt Corporation estimates that its demand function is Q=400 - 3P +41 +0.6 A where is the quantity demanded per month, P is the product's price in dollars), I is per capita disposable income in thousands of dollars), and A is the firm's advertising expenditures (in thou- sands of dollars per month). Population is assumed to be constant. a. During the next decade, per capita disposable income is expected to increase by $5,000. What effect will this have on the firm's sales? b. If Schmidt wants to raise its price enough to offset the effect of the increase in per capita disposable income, by how much must it raise its price? c. If Schmidt raises its price by this amount, will it increase or decrease the price elasticity of demand? Explain. Make sure your answers reflect the fact that elasticity is a negative number.

Answer 1

Part A

From the demand equation, we see that every $1,000 increase in income, quantity demand increases by 4. Then there is $5,000 increase income will increase quantity demand by 20 units.

Part B

The 20 units increases by quantity demanded the firm will increase the price. That is, every $1 increase in price will decrease quantity demanded by 3. So, the 20 unit decrease, then

20 X = 3

5 = $6.67 คว

Part C

Here both lead to higher price elastic demand. Suppose the question asked by if demand is more elastic after the increase in income and price. then

$\frac{\Delta Q}{\Delta P}$ is unchanged and $\frac{P}{Q}$ will change. Similarly, if the question asked by if the increase in price chokes off the increase in quantity demanded after an increase in income. So, this is a linear demand curve where high elastic demand.