3. A recent study determined the following elasticities for Volkswagen Beetles:

Question

3. A recent study determined the following elasticities for Volkswagen Beetles:

Price elasticity of demand = 2

Income elasticity of demand = 1.5

The supply of Beetles is elastic. Based on this information, are the following statements true or false? Explain your reasoning.

a. A 10% increase in the price of a Beetle will reduce the quantity demanded by 20%.

b. An increase in consumer income will increase the price and quantity of Beetles sold. Since price elasticity of demand is greater than 1, total revenue will go down.

Explanation / Answer

a. This statement is TRUE.

Elasticity = % change in quantity demanded/% change in price.

Given price hike as 10%, demand fall as 20%, substituting the values in the elasticity formula, we get,

elasticity = -20%/10%

Elasticity of demand is

Elasticity = -2, which is already given to us.

So the statement is correct.

b. This statement is FALSE.

When the consumer's income increases, at first just the quantity demand for beetles increases and the demand curve for beetles shift out to right. With this the prices increase. Because the supply being elastic, that is, the supply changes in more proportion than change in price and the supply curve also shifts to right, brings the equilibrium back. Thus, increasing the demand and hence the revenue.

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