Question

3. Suppose the demand function for a firm's product is given by In Q 7-1.5 In P 2 In P, -0.5 In M +InA where P = $15, P, = $6, M $40,000, and A $350. a. Determine the own price elasticity of demand, and state whether demand is b. Determine the cross-price elasticity of demand between good X and good c. Determine the income elasticity of demand, and state whether good X is a d. Determine the own advertising elasticity of demand. elastic, inelastic, or unitary elastic. Y and state whether these two goods are substitutes or complements. normal or inferior good.

Answer 1

Since the demand function given above is in log-log form, coefficients in the function represent elasticities with respect to their corresponding variables.

a) price elasticity of demand= -1.5

Since the absolute value of elasticity is greater than 1, demand is elastic.

b) coefficient on Py gives cross price elasticity and which is equal to 2. Because the elasticity is positive, increase in price of y leads to increase in demand for x, the goods are substitutes.

c) income elasticity= -0.5

Good X is an inferior good because its elasticity is negative, showing increase in income leads to decrease in demand.

d) own advertising elasticity is 1 which is the coefficient on lnA.