CHAPTER 3

DEMAND THEORY
1. A firm has estimated the following demand function for its
product:
Q = 58 2P + 0.10I + 15A
where Q is quantity demanded per month in thousands, P is
product price, I is an index of consumer income, and A is
advertising expenditures per month in thousands. Assume that
P = $10, I = 120, and A = 10. Use the point formulas to
complete the elasticity calculations indicated below.
(i) Calculate quantity demanded.
(ii) Calculate the price elasticity of demand. Is demand elastic,
inelastic, or unit
elastic?
(iii) Calculate the income elasticity of demand. Is the good
normal or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.
Solution:
(i) Q = 58 (2)(10) + (0.10)(120) + (15)(10) = 200
(ii) (2)(10/200) = 0.10 so demand is inelastic
(iii) (0.10)(120/200) = 0.06 so the good is normal and a
necessity
(iv) (15)(10/200) = 0.75
2. A firm has estimated the following demand function for its
product:
Q = 100 5P + 5I + 15A
where Q is quantity demanded per month in thousands, P is
product price, I is an index of consumer income, and A is
advertising expenditures per month in thousands. Assume that
P = $200, I =150, and A = 30. Use the point formulas to
complete the elasticity calculations indicated below.
(i) Calculate quantity demanded.

Managerial Economics: Principles

and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012

(ii) Calculate the price elasticity for demand. Is demand elastic,

inelastic, or unit
elastic?
(iii) Calculate the income elasticity of demand. Is the good
normal or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.
Solution:
(i) Q = 100 (5)(200) + (5)(150) + (15)(30) = 300
(ii) (5)(200/300) = 3.33 so demand is elastic
(iii) (5)(150/300) = 2.50 so the good is normal and a luxury
(iv) (15)(30/300) = 1.50
3. A firm has kept track of the quantity demanded of its output
during four time periods. Product price, consumer income, and
advertising expenditures were also recorded for each time
period. The information is provided in the table that follows. Use
it to calculate the arc elasticity of demand with respect to price,
income, and advertising.
Time Period
1
2
3
4
Quantity
120
80 100
80
Price
20
30
30
30
Income
150 150 250 250
Advertising
50
50
50
30
Solution:
The price elasticity of demand (using time periods 1 and 2) is
[(120 80)/(20 30)][(20 + 30)/(120 + 80)] = 1
The income elasticity of demand (using time periods 2 and 3) is
[(80 100)/(150 250)][(150 + 250)/(80 + 100)] = 0.44
The advertising elasticity of demand (using time periods 3 and
4) is
[(100 80)/(50 30)][(50 + 30)/(100 + 80)] = 0.44
4. A firm has kept track of the quantity demanded of its output
(Good X) during four time periods. The price of X and the prices
of two other goods (Good Y and Good Z) were also recorded for
each time period. The information is provided in the table that
follows. Use it to calculate the own-price arc elasticity of
Managerial Economics: Principles
and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012

demand and the two cross-price elasticities of demand.

Determine whether Good Y and Good Z are complements or
substitutes for Good X.
Time Period
1
2
3
4
Quantity of X
220 80
250
260
Price of X
15 25
15
25
Price of Y
10
10
5
10
Price of Z
20
20
20
30
Solution:
The own-price elasticity of demand (using time periods 1 and 2)
is
[(220 80)/(15 25)][(15 + 25)/(220 + 80)] = 1.87
The cross-price elasticity of demand for Good X with respect to
the price of Good Y (using time periods 1 and 3) is
[(220 250)/(10 5)][(10 + 5)/(220 + 250)] = 0.19
Good X and Good Y are complements.
The cross-price elasticity of demand for Good X with respect to
the price of Good Y (using time periods 2 and 4) is
[(80 260)/(20 30)][(20 + 30)/(80 + 260)] = 2.65
Good X and Good Z are substitutes.
5. The price of a good increases from $9 to $11 and, as a result,
the quantity of the good demanded declines from 120 to 80.
Calculate the price elasticity of demand using the arc formula
and determine whether demand is elastic, inelastic, or unit
elastic.
Solution:
[(80 120)/(11 9)][(11 + 9)/(80 + 120)] = 2.00 so demand
is elastic.
6. The demand function for a good is defined as Q = 20 0.5P.
Calculate the price elasticity of demand using the point formula
for P = 8 and determine whether demand is elastic, inelastic, or
unit elastic.
Solution:
(0.5)(8/16) = 0.25 so demand is inelastic.

Managerial Economics: Principles

and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012

7. The demand function for Good X is defined as QX = 20

0.5PX + 1.2PY, where PY is the price of Good Y. Calculate the
price elasticity of demand using the point formula for PX = 12
and PY = 10. Determine whether demand is elastic, inelastic, or
unit elastic with respect to its own price and whether Good Y is
a substitute or a complement with respect to Good X.
Solution:
(0.5)(12/26) = 0.23 so demand is inelastic with respect to its
own price.
(1.2)(10/26) = 0.26 so the two goods are substitutes.
8. The demand function for a good is defined as Q = 20 1.5P
+ 0.2I, where I is a measure of consumer income. Calculate the
price elasticity of demand using the point formula for P = 16
and I = 110. Determine whether demand is elastic, inelastic, or
unit elastic with respect to its own price and whether the good
is normal or inferior and whether it is a luxury or a necessity.
Solution:
(1.5)(16/18) = 1.33 so demand is elastic with respect to its
own price.
(0.2)(110/18) = 1.22 so the good is normal and is a luxury.
9. A firm has estimated the following demand function for its
product:
Q = 8 2P + 0.10I + A
where Q is quantity demanded per month in thousands, P is
product price, I is an index of consumer income, and A is
advertising expenditures per month in thousands. Assume that
P = $10, I = 120, and A = 10. Use the point formulas to
complete the elasticity calculations indicated below.
(i) Calculate quantity demanded.
(ii) Calculate the price elasticity of demand. Is demand elastic,
inelastic, or unit
elastic?
(iii) Calculate the income elasticity of demand. Is the good
normal or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.

Managerial Economics: Principles

and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012

Solution:
(i) Q = 8 (2)(10) + (0.10)(120) + (1)(10) = 10
(ii) (2)(10/10) = 2.0 so demand is elastic
(iii) (0.10)(120/10) = 1.2 so the good is normal and a luxury
(iv) (1)(10/10) = 1.0
10. A firm has estimated the following demand function for its
product:
Q = 400 5P + 5I + 10A
where Q is quantity demanded per month in thousands, P is
product price, I is an index of consumer income, and A is
advertising expenditures per month in thousands. Assume that
P = $200, I = 100, and A = 20. Use the point formulas to
complete the elasticity calculations indicated below.
(i) Calculate quantity demanded.
(ii) Calculate the price elasticity of demand. Is demand elastic,
inelastic, or unit
elastic?
(iii) Calculate the income elasticity of demand. Is the good
normal or inferior? Is it a necessity or a luxury?
(iv) Calculate the advertising elasticity of demand.
Solution:
(i) Q = 400 (5)(200) + (5)(100) + (10)(20) = 100
(ii) (5)(200/100) = 10.0 so demand is elastic
(iii) (5)(110/100) = 5.0 so the good is normal and a luxury
(iv) (10)(20/100) = 2.0
11. The price of a good increases from $8 to $10, and as a
result the quantity of the good demanded declines from 120 to
80. Calculate the price elasticity of demand using the arc
formula and determine whether demand is elastic, inelastic, or
unit elastic.
Solution:
[(80 120)/(10 8)][(10 + 8)/(80 + 120)] = 1.80 so demand
is elastic

Managerial Economics: Principles

and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012

12. The demand function for a good is defined as Q = 20 0.5P.

Calculate the price elasticity of demand using the point formula
for P = 30 and determine whether demand is elastic, inelastic,
or unit elastic.
Solution:
(0.5)(30/5) = 3.0 so demand is elastic
13. The demand function for Good X is defined as QX = 75
2PX 1.5PY, where PY is the price of Good Y. Calculate the
price elasticity of demand using the point formula for PX = 20
and PY = 10. Determine whether demand is elastic, inelastic, or
unit elastic with respect to its own price and whether Good Y is
a substitute or a complement with respect to Good X.
Solution :
(2)(20/20) = 2.0 so demand is elastic with respect to its own
price.
(1.5)(10/20) = 0.75 so the two goods are complements.
14. The demand function for a good is defined as Q = 45 2.5P
0.2I, where I is a measure of consumer income. Calculate the
price elasticity of demand using the point formula for P = 6 and
I = 100. Determine whether demand is elastic, inelastic, or unit
elastic with respect to its own price and whether the good is
normal or inferior and whether it is a luxury or a necessity.
Solution:
(2.5)(6/10) = 1.5 so demand is elastic with respect to its own
price.
(0.2)(100/10) = 2.0 so the good is inferior.
15. The demand function for a good is defined as Q = 50 P.
Calculate the price elasticity of demand using the point formula
for P = 25 and determine whether the demand is elastic,
inelastic, or unit elastic.
Solution:
(1)(25/25) = 1.0 so demand is unit elastic.
Managerial Economics: Principles
and Worldwide Applications, 7/e

Copyright (c) Oxford University Press, 2012