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Price Analysis
AEM 4150
Fall 2013
Solutions to Homework Assignment #1
1. Answer each of the following short questions, being careful to use the appropriate terminology in
each circumstance:
a) A change in the quantity supplied refers to a movement along the supply curve (i.e. a decrease
in price results in a decrease in the quantity supplied, ceteris paribus). A change in supply refers
to a shift in the supply curve due to a change in one of the other underlying factors determining
the supply (i.e. weather shock, input cost).

b) Consumer income (+ or -), Consumer tastes and preferences (+), Prices of competing goods (+
for substitutes, - for complements), Advertising (+), Population growth (+).

c) A good is own price inelastic if the percentage change in the quantity demanded of the good is
less than the corresponding percentage change in the good's own price. Conversely, a good is
own price elastic if the percentage change in the quantity demanded of the good is greater than
the corresponding percentage change in the good's own price, other things being equal. Non-
necessities or luxuries d i.e. car, food away from home, jewelry, movie ticket etc. are an
example of an own price elastic product and necessities i.e. food, gasoline, water, housing etc.
are an example of an own price inelastic.

d) True: The Total Revenue (or Total Expenditure) is highest where the own price elasticity of
demand is equal to -1. To the left of this point on the demand curve, demand is elastic, which
means that the total expenditure on the good (and hence revenue) can be increased by
decreasing the price of the good (since the increase the quantity demanded is proportionately
greater than the decrease in price). To the right of this point demand is inelastic and the total
expenditure on the good (and hence revenue) cannot be increased by increasing the price of the
good (since the decrease in the quantity demanded is proportionately smaller than the increase
in price).
An alternative way to make the judgment is through mathematical methods. Lets use the
demand function Q=8-2P, in page 34-35 in the note of Chapter 2, as an example to illustrate the
relation between revenue (R) and own price elasticity of demand (!
!
).
From ! ! ! !!" , we have
!"
!"
! !!
Hence, !
!
!
!"
!"
!
!
!
! !! !
!
!

Substitute P by ! !
!!!
!
, we have !
!
!
!"
!"
!
!
!
! !! !
!!!
!"
!
!!!
!

Solve for ! !
!
!!!
!
, hence ! !
!!!
!
!
!!!
!
!!!
!
,
Thus, !"#$% !"#"$%" !" ! ! ! ! !
!!!
!
! ! !
!!"!
!
!!!
!
!

Then, in order to get the relation between TR and !
!
, take first derivative TR with respect to !
!
!"#
!!
!
! !!
!
!
!"!!
!
!
!!!
!
!
!!
!
= 0, !
!
! !!
6 !"#$%&"' %" )*+,-./ 0"+*1"23 )!!&4'+*'% 5 -

Therefore, when !
!

<-1, TR increases with !
!

going up; When-1< !
!
<0, TR decreases with
!
!
going up; when !
!
= -1, TR reaches the maximum.

e) False: A change in the price of one good does not change the quantity demanded of another
good. It would change the Demand for the other good. In the case of complement, an increase
in the price of one good would lead to a decrease in the Demand for the other good.

2. Assume that you know the following values for the point elasticity of demand:
Own-price elasticity of demand for good X, !
!!
, is -1.25;
Cross-price elasticity of demand for good X relative to good Y, !
!"
, is 0.8;
Income elasticity of demand of good X, !
!"
, is -0.5.
Initially, P
x
= $5/unit, P
y
= $10/unit, average I = $20,000 and the Quantity demanded of X is 1,000
units.
a) !
!!
!
!!!
!
!!!
!
= -1.25, !!!
!
= 5, thus !!!
!
! !
!!
! !!!
!
= -1.25*5 = -6.25
Therefore the demand for X will decline by 6.25% from 1000 to 937.5 units.

b) !
!"
!
!!!
!
!!!
!
= 0.8, !!!
!
!
!!!!"
!"
= 10, thus !!!
!
! !
!"
! !!!
!"
= 0.8*10 = 8
The demand for X will increase (shift outwards) by 8% from 1000 to 1,080 units.
Since the demand for X shifted outwards as a result of an increase in the Py, the 2 goods X and
Y are substitutes.

c) !
!"
!
!!!
!
!!!
= -0.5, !!! !
!!""
!"!!!!
= -2.5, thus !!!
!
! !
!"
! !!! = -0.5*-2.5 = 1.25
The demand for X will increase (shift outwards) by 1.25% as a result of a decrease in income.
Therefore, X is an inferior good i.e. instant noodle, hamburger etc.

3. You have been hired as a price analyst for the Global Tire Company. Given the sale information of
the company, a marketing manager would like to know the following questions for future
marketing plan. Using arc-elasticity formula.
a) !
!!
!
!!
!
!!
!
!
!
!"#!
!!
!"#$
!
!
!!"#
!!
!"#$
!
!
!!!!!!!!!!!!
!""!!""
!
!""!!""
!
!!!!!!!!!!!!
!
= (-15)*(0.042) = -0.63
The own price elasticity of tire is inelastic because 0<|!
!!
|<1. The percentage change in the
quantity demanded of tire (0.63%) is less than the corresponding percentage change in the price
of tire (1%).

b) !!!
!
!
!"#!!""
!"#!!""
!
! -18.182, then !!!
!
! !!!
!
! !
!!
= (-18.182)*(-0.63) = 11.45 Thus,
!!!
!
! !!!!" !
!
!
!!!!!!!
!
!
!!!!!!!
!
! !"". Solve for !
!
= 12,335.98. Therefore, 12,335 tires sold if
the price of tire went down to $250 in 2014 from $300 in 2013.


!"#$%&"' %" )*+,-./ 0"+*1"23 )!!&4'+*'% 5 - 7

c) !
!"
!
!!
!
!!
!
!
!"#!
!!
!"#$
!
!
!"#!
!!
!"#$
!
!
!!!!!!!!!!!!
!"!!!!!!"!!!!
!
!"!!!!!!"!!!!
!
!!!!!!!!!!!!
!
= (-0.3)*(3.684) = -1.11.
The income elasticity of tire demand is very elastic |!
!"
|>1 and the companys product is
considered as an inferior good (!
!"
! !) because the lower income, the higher demand.

d) !
!"
!
!!
!
!!
!
!
!
!"#!
!!
!"#$
!
!
!"#!
!!
!"#$
!
!
!!!!!!!!!!!!
!!!!!!!""
!
!!!!!!!""
!
!!!!!!!!!!!!
!
= 30*(0.1) = 3
The cross price elasticity of tire demand is elastic !
!"
>1 This means that the percentage change
in the quantity demanded of Global Tire Company (3%) is more than the corresponding
percentage change in the main competitors price (1%).

e) Yes, because own price elasticity of tire is inelastic. When demand is inelastic, if the price
increases by 1%, the quantity demanded will decrease by less than 1%. Total revenue will
increase.

4. The following walnut supply equations were estimated

!"!
!
!
! !!!" !!!!!"#$!
!!!
!
!!!!"!"#
!
!!!!"!
!
!!!!"#$!
!!!
!


a) Take derivative of ln!
!
!
w.r.t. !"!
!!!
!
;
!!"#
!
!
!!"#
!
!
!
!!
!
!
!!
!
!
!
!
!
!
!
!
!
! !
!!
! !!!!".
The elasticity of walnut supply with respect to lagged own price is inelastic (0<|!
!!
!<1)
The percentage change in the quantity supplied of walnut this year (0.003%) is very less than
the corresponding percentage change in the walnut price last year (1%). On the other hand, the
last year price has a small effect to the change in walnut supply this year.

b) Take derivative of ln!
!
!
w.r.t. !"#
!
;
!!"#
!
!
!!"#
!
!
!!
!
!
!!"#
!
!
!
!
!
!
!
!!
!
!
!!"#
!
!
!
!
!
!
!
!"#
!
!"#
!
! !!!"
Rearrange so that !!!" !
!!
!
!
!!"#
!
!
!"#
!
!
!
!
!
!
!"#
!
! !
!"#
!
!
!"#
!

Hence, !
!"#
! !!!" ! !"#
!
=0.03*58 = 1.74.

The elasticity of walnut supply with respect to March temperature is elastic (!
!"#
>1)
The percentage change in the quantity supplied of walnut this year (1.74%) is more than the
corresponding percentage change in March temperature (1%). On the other hand, a small
temperature change in March has a quite large impact on walnut supply.

c) Take derivative of ln!
!
!
w.r.t. !"!
!!!
!
;
!!"#
!
!
!!"#
!!!
!
!
!!
!
!
!!
!!!
!
!
!
!!!
!
!
!
!
! !
!!
!!!
! !!!".
The elasticity of walnut supply with respect to lagged supply is inelastic (0<|!
!!
!!!
|<1)
The percentage change in the quantity supplied of walnut this year (0.69%) is very less than the
corresponding percentage change in the walnut supply last year (1%). On the other hand, the
last year walnut supply has a small effect to the change in walnut supply this year.