1. The quantity demanded of good A increases by 5 percent when the price of good

Question

1. The quantity demanded of good A increases by 5 percent when the price of good B rises by 10 percent and other things remain the same. Are goods A and B complements or substitutes? Describe how the demand for good A changes and calculate the cross elasticity of demand. (10Marks)

2. When income rises by 5 percent and other things remain the same, the quantity demanded of good C increases by 1 percent. Is good C a normal good or an inferior good? Describe how the demand for good C changes and calculate the income elasticity of demand for good C. (10Marks) [Total 20 Marks]

Explanation / Answer

1)

Quantity demanded of A increases when Price of good B increases, it suggests that these goods are substitutes for each other. Hence, when price of one good rises, demand for another good increases.

Elasticity of demand = Percentage Change in demand for good A / Percentage change in price of good B.

Ed = 5 /10

= 0 .5

2)

Increase in income leads to rise in demand for good C. thus, demand for good C is positively related to the income. it is normal good.

For normal good, rise in income leads to rise in demand.

Income Elasticity = Percentage change in demand / Percentage change in Income

= 1/5

= 0 .2

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