Question

Q.3 (15 points) Consider the market for good A. The quantity supplied is shown in the following table. Column 3 shows the quantity demanded of good A by a household when household income is $60,000. Column 4 shows the quantity demanded of good A when household income is $70,000 (2) (3) (1) Quantity Quantity demanded Quantity demanded Price Supplied (income = $ 60,000) (income = $70,000) $10.00 100 60 20 $8.00 80 80 30 $6.00 60 90 60 40 100 70 $4.00 $2.00 80 20 0 110 115 $0.00 90 (a) When household income is $60,000, what is the equilibrium quantity? What is the equilibrium price? (b) When household income is $70,000, what is the equilibrium quantity? What is the equilibrium price? (c) Calculate the income elasticity of demand when the price of good A = $4 using the midpoint method. (d) Is good A normal good? Give an example of good A. (e) Price of good B increases, the demand for good A decreases. Is the cross-price elasticity positive or negative? Are good A and good B complements or substitutes?

Answer 1

Q 3.

Equilibrium arises where Quantity demand = Quantity supplied

a)

When income= $60000:

Quantity demand and quantity supplied are equal at the Price= $8(equilibrium price) and Equilibrium quantity= 80

b)

When income= $70000:

Quantity demand and quantity supplied are equal at the Price= $6(equilibrium price) and Equilibrium quantity= 60

c)

Mid point formula for income elasticity:

Income elasticity= [(Change in Quantity)/(Change in income)] x [(Old income + new income) / (Old Q+new Q)]

When Price is $4:

Old quantity= 100

New Quantity= 70

Change in Q= -30

Old Q+New Q= 170

Old income= $60000

New income= $70000

Change in income= $10000

Old income + new income= $130,000

Income elasticity= [-30/10000] x [130,000/170]= -2.294

d)

As income elasticity is negative, it implies that as income increases the demand for good A decreases which means Good A is an inferior good. For normal good, the demand should increase with increase in income. So Good A is not a normal good.

Example of inferior good is Black and white televisions are inferior to color televisions.

e)

Price of good B increase, the demand for good A decreases. It implies that there is a negative relationship between price of Good B and demand for good A as they are moving in opposite direction. So cross price elasticity is negative.

So as the price of good B increases people starts to consume less of good A which implies that these goods should be use together to satisfy a given thats why the increase in price of good B makes it expensive to use good A. This implies that these goods are complementary goods.