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Interpreting elasticity coefficients

Price elasticity of demand and Income elasticity of demand

(1) (2) (3) (4)
Electricity Price Natural gas Price Oil Price Income
Electricity -0.6 1.6 1.0 0.9
Natural Gas 1.1 -1.7 1.3 0.8
Oil 0.8 1.5 -1.9 -1.2

a) From those coefficients would you suggest electricity company to increase or decrease electricity price to make more revenues. Justify.

b) After a 25% increase on oil price and considering the fact electricity company cannot increase their production of electricity what price variation of electricity is require to cancel any change on electricity demand. Justify.

c) What impacts will have the construction of a new natural gas company on oil demand. And on electricity demand? Justify.

Solution Preview

a) From those coefficients would you suggest electricity company to increase or decrease electricity price to make more revenues. Justify.

From the above table, we find that value of own price elasticity coefficient for electricity company is (-0.6). Absolute value of price elasticity is less than 1. We can say that demand is inelastic.

For any change in prices, percent change quantity demanded is less than percent change in price in case of inelastic demand. Total revenue will increase in case price of electricity increases.

Company should increase price to make more revenues.

b) After a 25% increase on oil price and considering the fact electricity company cannot increase their production of electricity what price ...

Solution Summary

The solution discusses the effect of price increase on the total revenue with the help of given elasticity data. It also calculates the needed price hike to offset the demand changes due to increase in oil prices.

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