#ECO202: Price and Income Elasticity of Demand

Price and Income Elasticity of Demand

#Question 1 Note: For all sub-questions of Question 1, your answer should not exceed 500 words excluding figures and tables.

(a) Consider the following information for a product X and a related product Y:

Quantity of X traded Price of X Income of Consumers Price of Y 12,000 $1.00 $10,000 $1.00 16,000 $0.80 $9,000 $1.20

Classify X in terms of its price and income elasticities of demand and establish the relationship between product X and product Y. How does knowledge of the price elasticity of demand, the income elasticity of demand, and the cross-price elasticity of demand help a firm in making business decisions? Explain with suitable examples.

(45 marks)

(b) The demand and supply functions of rice is given as P = 200 – 0.5Q and P = 100 + 0.5Q, respectively. Solve for the equilibrium price and quantity in the rice market. If the government implements a price floor of $180 per unit of rice, appraise the efficiency of the rice market by computing the consumer surplus, the producer surplus, and the deadweight loss (if any) in the rice market. Support your answers with a suitable rice market diagram and comment on the winner and loser under this policy.

(30 marks)

(c) To discourage the consumption of a product, the government should impose a tax on

the consumers instead of the producers. Do you agree? Explain with a suitable market diagram.

(25 marks)