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Cross-Price Elasticity

I need help with answering these questions:

Suppose the demand for Apple iPhones is characterized by the following point elasticities: (own) price elasticity = -.12, cross-price elasticity with Blackberry phones = +.03, and income elasticity = 1.5. Based on these numbers, answer the following questions. Explain your answers and show your work.

a. What would happen to the demand for iPhones if consumer income rises by 10%? Be specific. Are iPhones a normal or an inferior good? Explain.

b. The price of iPhone recently was raised 10%, but, after the price increase, revenue from iPhone sales increased. If the 'law of demand' tells us that an increase in price leads to a decrease in quantity demanded, how can the above be explained? Support your answer using the information provided.

c. How would the demand for iPhones change if the price of a Blackberry rose by 2%? Are the two goods strong or weak substitutes? Be specific and explain your answer using the information provided.

Solution Preview

a. Normal goods are any goods for which demand increases when income increases and falls when income decreases, the iPhone is obviously a such example. Most of the good we encounter are normal goods, with the only few exceptions (such as the demand for fast food, as the demand actually drops when income increases). Such are called inferior goods. Since iPhones are normal, a 10% increase in income will lower the demand by 15% (1.5 X 10%).

b. ...

Solution Summary

Cross-Price Elasticity