Business Economics

Q.3

  a).

  Suppose

  the

  monthly

  income

  of

  an

  individual

  increases

  from

  Rs

  20,000

  to

  Rs

  25,000

  which

increase

 his

 demand

 for

 clothes

 from

 40

 units

 to

 60

 units.

 Calculate

 the

 income

 elasticity

 of

 demand.

b).

 Quantity

 demanded

 for

 tea

 has

 increased

 from

 300

 to

 400

 units

 with

 an

 increase

 in

 the

 price

 of

 the

coffee

 powder

 from

 Rs

 25

 to

 Rs

 35.

 Calculate

 the

 cross

 elasticity

 of

 demand

 between

 tea

 and

 coffee.

Solution:

a).

 Income

 elasticity

 of

 demand

 describes

 the

 relative

 change

 in

 demand

 for

 a

 product

 as

 a

 result

 of

changes

 in

 consumer

 income.

 The

 coefficient

 of

 income

 elasticity

 of

 demand

 is

 the

 ratio

 of

 relative

change

 in

 the

 volume

 of

 demand

 for

 the

 item

 to

 a

 relative

 change

 in

 the

 income

 of

 the

 consumer.

Income

 elasticity

 of

 demand

 indicates

 whether

 a

 product

 is

 a

 normal

 good

 or

 an

 inferior

 good.

When

  the

  quantity

  demanded

  of

  a

  product

  increases

  with

  an

  increase

  in

  the

  level

  of

  income

  and

decreases

 with

 decrease

 in

 level

 of

 income,

 we

 get

 a

 positive

 value

 for

 income

 elasticity

 of

 demand.

 A

positive

  income

  elasticity

  of

  demand

  stands

  for

  a

  normal

  (or

  superior)

  good.

  When

  the

  quantity

demanded

 of

 a

 product

 or

 service

 decreases...