Question

Assume that demand for a service depends upon price and income, where the price elasticity of demand is Ep = –0.6 and income elasticity is Ey = 1.2. If price falls by 4% and income rises by 2%, the quantity demanded of the service will _____.

(a)-falls by 2.4%
(b)-falls by 9.6%
(c)-not affected since the price change and income change will exactly offset one another.
(d)-increase by 6%
(e)-increase by 4.8%

Answer 1

Increase by 4.8%

Step-by-step explanation:

The 4% price reduction will cause an increase in demand by 2.4%.

`\Delta Q/Q=\epsilon_p*\Delta P/P=(-0.6)*(-0.04)=0.024`

The 2% rise in income will cause an increase in demand by 2.4%

`\Delta Q/Q=\epsilon_I*\Delta I/I=(1.2)*(0.02)=0.024`

If we take into account both variations and add them, we have an increase in demand by 2.4%+2.4% = 4.8%