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Discussion of Elasticity

Scenario: Suppose that the current market price of VCR's is $300, that the average consumer disposable income is $30,000, and that the price of DVDs (a substitute for VCR's) is $500. Under these conditions annual U.S. demand for VCR's is 5 million per year. Statistical studies have shown that for VCR's the own-price elasticity of demand is -1.3. The income elasticity of demand for VCR's is 1.7. The cross-price elasticity of demand for VCR's with respect to DVDs is 0.8. Use this information to predict the annual number of VCR's sold under the following conditions:

(a) Increasing competition from Korea 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 to $31,500 with prices unchanged.

(c) Technical improvements in DVD players causes the price of a DVD to fall to $400, with the price of VCRs and income unchanged.

(d) All of the events described in parts 1-3 occur simultaneously.

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Solution Preview

a) Own price elasticity = -1.3
Change in price = (270-300)/300=-10%
Change in quantity demanded = Own price elasticity * Change in price = -1.3*-10%=13% (demand will increase by 13%)
New demand level = 5 million ...

Solution Summary

In about 140 words, this solution computes various different forms of elasticity which each relate to a specific situation on the subject of VCR's. All calculations and formulas are included in this response.