Economics: Price Elasticity and Revenue Implications Assignment

This assignment delves into the core concepts of price elasticity, income elasticity, and cross-price elasticity. It examines how these elasticities influence revenue generation for businesses. The assignment explores the impact of price changes on the quantity demanded, distinguishing between elastic and inelastic demands. It also covers how income changes affect the demand for normal and inferior goods. Furthermore, the assignment discusses cross-price elasticity and its implications for substitute and complementary goods. Finally, the assignment provides insights on how businesses can leverage these concepts to make informed decisions about pricing strategies. It provides a framework for understanding how price adjustments can be optimized to maximize revenue, considering different scenarios based on the elasticity of demand.

PART A
1) Price elasticity of demand – This is used to estimate the effect of changes in price on the
quantity demanded. Typically, for normal goods this elasticity is negative. However, for
inferior goods, this elasticity would be positive. A magnitude of lesser than 1 indicates inelastic
demand. However, a magnitude in excess of 1 indicates elastic demand.
2) Income elasticity – This is used to estimate the impact of changes of income on the
quantity consumer for a given good or service. Typically, for normal goods, the demand tends
to increase with higher income and hence income elasticity is positive. On the contrary, for
inferior demands, there would be a decrease in quantity demanded as income rises. Thus, one
can differentiate between normal and inferior goods based on income elasticity.
3) Cross price elasticity of demand – This is used to estimate the impact on the demand of a
particular product or service when the price of a different product or service tends to change.
A positive cross price elasticity would imply that the underlying products are complements. On
the other hand, a negative cross price elasticity would imply that the underlying products are
substitutes. Thus, based on the sign of cross price elasticity, the nature of relationship between
goods can be determined. Further, a magnitude of zero would imply no relation between the
goods.
PART B
1) Lower price
This is because the demand is very sensitive to price and hence lower price would result in
disproportionate increase in quantity demanded. As a result, lower prices would lead to higher
revenues.
2) Raise price
This is because the demand is highly inelastic and even at higher prices, the impact on demand
would be very minimal. As a result, the revenue would increase by raising the prices to a higher
level.

3) No changes
Changing the prices would not result in any change in revenue as the quantity demanded would
be appropriately adjusted to balance the impact.