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Economics - Price Elasticity of demand

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Suppose that the current market price of VCRs is $300, that the average consumer disposable income is $60,000, and that the price of DVDs (a substitute for VCRs) is $500. Under these conditions annual U.S. demand for VCRs is 10 million per year. Statistical studies have shown that for VCRs the own-price elasticity of demand is -1.5. The income elasticity of demand for VCRs is 2.0. The cross-price elasticity of demand for VCRs with respect to DVDs is 0.8. Use this information to predict the annual number of VCRs sold under the following conditions:

a. Increasing competition from Asia causes VCR prices to fall to $270 with income and the price of DVDs is unchanged.

b. Income tax reductions raise average disposable personal income by 5% with prices unchanged.

c. An inventor in Menlo Park invents a cheaper way to produce DVDs, reducing the price of a DVD by 20% to $400, with the price of VCRs and income unchanged.

d. Which of the above changes lead to a shift in the demand curve and which lead to a movement along the demand curve?

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Solution Summary

own-price, income, and cross-price elasticity of demand

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a. Increasing competition from Asia causes VCR prices to fall to $270 with income and the price of DVDs is unchanged.

for this problem we use the price elasticity of demand:
%Change demand / change price = -1.5
We are given the decrease in price, which gives us the %change:
% change price = 30/ 300 = .1
Therefore,
%Change demand / .1 = -1.5

%change demand = 15%

There will be an increase of 15%.

10 million x .15 = 1.5 million

Therefore ...

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