Question 5 (b)
Price elasticity versus cross-price elasticity, and the burger-noodles estimate
6 marks
- Time to write
- About 12 minutes
Question
Question 5 (b) · 6 marksDistinguish between price and cross-price elasticity of demand. Suppose a rise in the price of burger from ₹50 to ₹55 per unit results in an increase in demand for noodles from 150 units to 180 units. Estimate the cross price elasticity of demand and comment on the nature of the two goods.
Reworded from the university paper: names and figures differ, the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.
Before you write
Read off the question and its marks
Read from the question
- Distinguish betweenSet the differences out in a table, basis by basis, not as two separate essays.
- and comment onThe comment carries marks too: say what the figures show, in two or three lines.
- EstimateFormula first, then the working, then the answer with its unit (₹, %, units).
What the paper leaves open
The paper prints the marks once, (6+6+6), at the end of part (c): 6 marks for each of (a), (b), (c). This part carries 6 marks. The paper names no method for the cross-price elasticity; either the simple percentage-change method or the mid-point method is acceptable.
Write it in this order
- Read the data; note exactly what is asked 1 min
- 1 Price and cross-price elasticity distinguished 3 marks 5 min
- 2 Cross-price elasticity estimated 2 marks 3 min
- 3 Nature of the two goods 1 mark 2 min
- Check: arithmetic, units (₹, %), final answer underlined 1 min
Short on time? Step 1 carries 3 of the 6 marks: guard its minutes.
Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.
Solution
Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.
Price elasticity of demand. It measures how strongly the quantity demanded of a good responds to a change in that good's own price:
eP = (% change in quantity demanded of X) ÷ (% change in the price of X).
Since quantity demanded falls when price rises, its value is negative, and its absolute value is usually quoted. Demand is elastic when that value exceeds 1 and inelastic when it is below 1.
Cross-price elasticity of demand. It measures how strongly the quantity demanded of one good responds to a change in the price of another, related good:
eXY = (% change in quantity demanded of X) ÷ (% change in the price of Y).
Its sign shows how the goods are related. For substitutes a rise in the price of one raises the demand for the other, so eXY is positive; for complements a rise in the price of one lowers the demand for the other, so eXY is negative. For unrelated goods it is zero.
| Basis | Price elasticity | Cross-price elasticity |
|---|---|---|
| Whose price changes | the good's own | a related good's |
| Usual sign | negative | positive for substitutes, negative for complements |
| What it shows | how responsive buyers are, elastic or inelastic | whether two goods are substitutes or complements, and how closely related |
| Effect on the demand curve | a movement along the good's own curve | a shift of the good's curve |
Estimate for burgers and noodles. The price of a burger (Y) rises from ₹50 to ₹55, and the demand for noodles (X) rises from 150 to 180 units.
Percentage method (changes on the starting values):
- % change in quantity of noodles = (180 – 150) / 150 × 100 = 20%;
- % change in the price of burgers = (55 – 50) / 50 × 100 = 10%;
- eXY = 20 ÷ 10 = +2.
Mid-point method (changes on the averages, which gives the same answer in either direction):
- quantity: 30 / 165 = 18.18%; price: 5 / 52.5 = 9.52%;
- eXY = 18.18 ÷ 9.52 = +1.91.
Nature of the two goods. The cross-price elasticity is positive by either method: a dearer burger raises the demand for noodles. Burgers and noodles are therefore substitutes, as when diners at a food court switch to noodles when burgers cost more. Its size, about 2, is greater than 1, so the demand for noodles is quite sensitive to the burger price: for these buyers the two are close substitutes.
Where the 6 marks sit
| # | Component | Marks |
|---|---|---|
| 1 | Price and cross-price elasticity distinguished | 3 |
| 2 | Cross-price elasticity estimated | 2 |
| 3 | Nature of the two goods | 1 |
| Total | 6 |
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