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Demand Function and Elasticity

The document discusses the demand function for Midwest Cable TV service and asks the reader to determine whether several statements about elasticities and the demand curve are true or false. It provides the demand function, current values for variables, and an explanation of the correct answers. Some key points: - The demand curve shows that demand is elastic with respect to price but inelastic with respect to income. - 'Home movies' are a complementary good to cable TV, so their prices are negatively correlated. - A 5% increase in income would lead to an 8% increase in demand, not 16% as stated. - Midwest's sales are determined by plugging current values into the demand function, not over

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Harshita Rajput
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470 views3 pages

Demand Function and Elasticity

The document discusses the demand function for Midwest Cable TV service and asks the reader to determine whether several statements about elasticities and the demand curve are true or false. It provides the demand function, current values for variables, and an explanation of the correct answers. Some key points: - The demand curve shows that demand is elastic with respect to price but inelastic with respect to income. - 'Home movies' are a complementary good to cable TV, so their prices are negatively correlated. - A 5% increase in income would lead to an 8% increase in demand, not 16% as stated. - Midwest's sales are determined by plugging current values into the demand function, not over

Uploaded by

Harshita Rajput
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Please refer it is an interesting question related to demand elasticity and function

(Interpretation of elasticities) with solution. Give you idea how to write answers. This
question is just for reference and practice, I know that quantitative part is little bit
complex …………. I hope you will enjoy.

Interpretation of elasticities

Midwest Cable TV has estimated the demand for its service to be given by the
following function:

Where,

Q = monthly sales in units

P= price of the service in $

A= promotional expenditure in $’000

Y= average income of the market in $’000

P0= price of ‘home movies’ in $

The current price of Midwest is $60, promotional expenditure is $120,000, average


income is $28,000, and the price of ‘home movies’ is $45.

Indicate whether the following statements are true or false, giving your reasons and
making the necessary corrections.

a. If Midwest increases its price this will reduce the number of its customers.

b. If Midwest increases its price this will reduce its revenues.

c. People’s expenditure on the cable TV service as a proportion of their income will


increase when their income increases.

d. If Midwest increases its price this will increase the sales of ‘home movies’.
e. ‘Home movies’ are a substitute for cable TV.

f. A 5 per cent increase in income will increase demand by 16 per cent.

g. A 10 per cent increase in price will reduce demand by 12 per cent.

h. Current sales are over a million units a month.

i. The demand curve for Midwest is given by:

j. Midwest’s sales are more affected by the price of ‘home movies’ than by the price of
its own service.

k. If Midwest increases its price this will reduce its profit.

Solution

a. True; customers and quantity demanded are synonymous in this case, and there is an
inverse relationship between Q and P, as seen by the negative price elasticity.

b. True; demand is elastic, since the PED is greater than 1 in absolute magnitude.
Therefore an increase in price causes a greater than proportional decrease in quantity
demanded and a fall in revenue.

c. True; this is because the YED is greater than 1, indicating that cable TV is a luxury
product. Note that the statement would be false if the good were a staple. For staples,
although expenditure on the product increases as income increases, expenditure as a
proportion of income falls, since expenditure rises more slowly than income.

d. False; the two products are complementary, shown by the CED being negative;
therefore an increase in the price of one product will reduce the sales of the other. It
appears therefore that ‘home movies’ is a cable channel.

e. False; the two products are complementary, shown by the CED being negative.

f. False; YED = 1.6; therefore using the simple elasticity formula (reasonably accurate for
small changes) the change in demand will be 1.6 x5%=8%.

g. False; change is 1.2x10%=12%, but this is a change in quantity demanded,


corresponding to a movement along a demand curve (unlike the previous part of the
question, which involves a shift in the demand curve).
h. False; current sales are given by

i. False; the demand curve is given by

j. True; the CED is larger in absolute magnitude than the PED. This is an unusual
situation but arises because of the nature of cable TV service. The service is only a
means to an end, that of receiving certain channels.

k. False; since demand is elastic, an increase in price has an unknown effect on profit.
More information would be required.

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