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Income Elasticity

During the past year,MP sold 150,000pairs of brake shoes at an average wholesale price of $13per pair. This year, GNP per capita is expected to fall from $21,000 to 19000 as nation enters a steep recession. Without any price change, MP expects current year sales to fall to 100,000.

a. Calculate the implied arc income elasticity of demand.
b. Given the projected fall in income, sales mgr thinks current volume of 150,000 units can only be maintained with a price cut of $1 per unit. on this basis,calculate the implied arc price elasticity of demand.
c. Holding all else equal, would a further increase in price result in higher or lower total revenue?

Solution Preview

a. Calculate the implied arc income elasticity of demand.

Arc elasticity measures the average elasticity over some range of a function.
In this case, ELgdp = (dQ/dGDP) * [(GDP1 + GDP 2)/(Q1 + Q2)]
ELgdp = ...

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The solution answers the question(s) below.

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