Question

1) A U.S. Department of Agriculture study of the demand for food products showed that the price elasticity of demand for potatoes is -0.42; the elasticity of demand for potatoes with respect to the price of tomatoes is 0.09; and the income elasticity of demand for potatoes is 0.10. a. Based on these figures, is the demand for potatoes elastic or inelastic? How can you tell? Explain.


b. Based on these figures, are potatoes a normal good or an inferior good? How can you tell? Explain.


c. If the price of potatoes falls by 5%, by what percentage will the quantity of potatoes demanded change? Will it rise or fall? Show your work.


d. If the price of potatoes falls by 5%, by what percentage would you expect total consumer spending on potatoes to change? Will consumers’ total spending on potatoes rise or fall? Carefully explain your answer.


e. If consumer incomes rise by 10%, by what percentage will the quantity of potatoes demanded change? Will it rise or fall? Show your work.


f. If consumer incomes rise by 10% (as in the last question), would the share of consumer income spent on potatoes rise, or would it fall? Calculate an estimate of the percentage change in the share of income spent on potatoes as a result of a 10% increase in income. Explain your reasoning.

g. Based on the figures above, are potatoes and tomatoes complements, or are they substitutes? Why? Explain your reasoning.


h. If the price of tomatoes rises by 10%, by what by what percentage will the quantity of potatoes demanded change? Will it rise or fall? Show your work.


i. Suppose you’re working as an economist with the Idaho Potato Growers Institute, and your boss asks you to predict the future growth rate of potato sales. You estimate that consumer’s incomes will grow at a rate of 2% per year in the future, and that the price of potatoes will fall by 1% per year. By what percentage do you estimate that the sales of potatoes will change each year in the future? Will it rise or fall? Show your work.

Answer 1

a. Demand for potatoes is inelastic as absolute value of the elasticity is less than 1.

b. Since income elasticity of demands for potatoes is postive, it means that when income rises, the demand for potato rises. So it is a normal good.

c. Price elasticity of demand for potatoes is -0.42
Price elasticity of demand = Percentage change in quantity demanded/Percentage change in price
Percentage change in quantity demanded = -0.42 x -5 = 2.1%
Quantity demanded of potatoes will rise by 2.1%

d. Suppose initially price of potatoes was 10 and consumer was purchasing 100 potatoes

Initial Expenditure on potatotes = 10 x 100 = 1000

Now price of potatoes is 9.95, consumer will purchase 102.1 potatoes

new Expenditure on potatotes = 9.95 x 102.1 = 1015.895

So expenditure on potatoes rises by = 1.5895%