Question 1.

A. Price Elasticity of demand "ÃÂPrice elasticity of demand is defined exactly as the percentage change in the quantity demand divided by the percentage change in price.'(handout) The formula is: Ped (e) = Percentage change in quantity demand = %DQ Percentage change in price %DP So for example if a firm increases its product price by 5%, and because of this the quantity demand of the product leads to a 10% decrease, the price elasticity will be 0.5.

Ped = (-) 0.05 = (-) 0.5 (+) 0.10 The most important feature about price elasticity is that firms can get useful information about the effect of a price change on total revenue and they are able to accurately calculate it.

We could have three specific types of price elasticity: ÃÂÃÂ· Inelastic when the elasticity is smaller than 1 (e < 1). It means that even if the price changes significantly, the quantity demanded of the product is not going to change that much.

ÃÂÃÂ· Unit elastic is a situation in which the percentage change in quantity divided by the percentage change in price equals 1 (e = 1). E.g. Insulin for diabetic patients ÃÂÃÂ· Elastic (e > 1) it accrues when relative changes in quantity are larger than relative changes in price. If demand is elastic, a price increase lowers total revenue and a decrease in price raises total revenue.

Price elasticity can range from completely inelastic, where e = 0, to perfectly elastic where e = ÃÂÃÂ¥.

B. Income elasticity of demand The income elasticity of demand is the percentage change in quantity demanded divided by the percentage change in consumer income.

The formula is: Yed = Percentage change in quantity demanded = %DQ Percentage change in income %DI E.g. if the income changes to +20% and the...