Numerical Problems on Demand Analysis and consumer’s equilibrium

1. Consider the following demand function

Q1 = 10 – 5P1 + 10Y + 6P2

where
Q1 is quantity demanded of commodity 1
P1 is price of commodity 1
Y is income of consumer.
P2 is price of commodity 2

Determine price, income and cross elasticities.

Hints:

Q1 P1
Price Elasticity (ep)= – * ; (here price elasticity is negative since, normally, quantity
P1 Q1
demanded varies inversely with price, ceteris paribus.)

Q1 Y
Income Elasticity (ey)= *
Y Q1

Q1 P2
Cross Elasticity (ec)= *
P2 Q1

2. Question: Demand (Q) is Q - 110 = - 4P, where P is Price. What is price elasticity at P=Rs. 5?
Comment on the result.

3. Question: The accompanying table shows the price and monthly quantity sold of Arrow T-shirts in the
town according to the average income of the city newly employed youth.

Price of T-shirt Quantity of T-shirts demanded when Quantity of T-shirts demanded when
(Rs) the average income of newly the average income of newly
employed youth is Rs. 20,000 employed youth is Rs, 30,000
400 3,000 5,000

5 00 2,400 4,200
6 00 1,600 3,000
700 800 1,800

a. Calculate the price elasticity of demand when the price of a T-shirt rises from Rs. 500 to Rs.600 and
the average income is Rs. 20,000. Also calculate it when the average income is Rs. 30,000.

b. Calculate the income elasticity of demand when the price of a T-shirt is Rs. 400 and the average income
increases from Rs. 20,000 to Rs. 30,000. Also calculate it when the price is Rs.700.
Solution:

a. When Income is Rs. 20,000

Initial Price (P1) = Rs. 500

Initial Demand (Q1) = 2,400
Final price (P2) = Rs 600
Final Demand (Q2) = 1,600

dQ P1
Price Elasticity (ep) = – * ; (here price elasticity is negative since, normally, quantity
dP Q1
demanded varies inversely with price)

1600  2400 500

= – *
600  500 600
= 6.66

Demand for the commodity is price elastic since ep> 0.

Similarly calculate ep, when income is Rs. 30000

b. When price is Rs. 400

Initial income (Y1) = Rs. 20000

Initial Demand (Q1) = 3000
Final income (Y2) = Rs 30000
Final Demand (Q2) = 5000

dQ Y1
Income Elasticity (eY) = * ; (here income elasticity is positive since, for normal
dY Q1
goods, quantity demanded varies directly with income)

5000  3000 20000

= *
30000  20000 3000
= 1.33

Demand for the commodity is income elastic since eY > 0.

Similarly calculate ey when price is Rs.700

4. Question: The accompanying table lists the cross-price elasticities of demand for several goods, where
the percent quantity change is measured for the first good of the pair, and the percent price change is
measured for the second good.

Goods Cross-price elasticities of demand

Air-conditioning units and kilowatts of electricity -0.34

Coke and Pepsi +0.63

High-fuel-consuming long distance traveling car and -0.28

diesel

Domino’s Pizza and Jasuben’s Pizza in Law Garden +0.82

Butter and Ghee +1.54

a. Explain the sign of each of the cross-price elasticities. What does it imply about the relationship
between the two goods in question?
b. Compare the absolute values of the cross-price elasticities and explain their magnitudes. For example,
why is the cross-price elasticity of Domino’s Pizza and Jasuben’s Pizza less than the cross-price elasticity
of Butter and Ghee ?
c. Use the information in the table to calculate how a 5% increase in the price of Pepsi affects the quantity
of Coke demanded.
d. Use the information in the table to calculate how a 10% decrease in the price of diesel affects the
quantity of long-distance diesel car demanded.

Solution:
1. When cross elasticity is negative, the related commodities are commentaries.
When cross elasticity is positive, the commodities are substitutes.

Here, (Air-conditioning units and kilowatts of electricity), (High-fuel-consuming long distance traveling
car and diesel) are complimentaries.
(Domino’s Pizza and Jasuben’s Pizza in Law Garden), (Coke and Pepsi) and (Butter and Ghee) are
substitutes.

Similarly, Air-conditioning units and kilowatts of electricity are more closely related than High-fuel
consuming long distance traveling car and diesel. As cross elasticity of Air-conditioning units and
kilowatts of electricity (absolute value) is more than that of High-fuel consuming long distance traveling
car and diesel.

2. Here cross elasticity between Domino’s Pizza and Jasuben’s Pizza is 0.82 and that of Butter
and Ghee 1.54. Since cross elasticity of butter and ghee is more than that of Domino’s Pizza
and Jasuben’s Pizza. Butter and ghee are more close substitytes.
5. Consider a competitive market for which the quantity demanded and supplied at various prices as
follows:

P rice Quantity Demanded Quantity Supplied

(Rs.)
60 22 14
80 20 16
100 18 18
120 16 20

From the above table, answer the following questions.

1. Calculate price elasticity demand if price falls from Rs.100 to Rs. 80

2. What is the equilibrium price and quantity?
3. Suppose if the government sets a price ceiling of Rs.80, will there be a shortage and if
so, how large will it be?

6. FlipKart offers a 10% discount on every book it sells.

Volume of sales before the 10% discount 1.55 million

1.65 million
Volume of sales after the 10% discount

Calculate price elasticity of demand.

Solution:

𝑃𝑟𝑜𝑝𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒(𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒) 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑

eP =
𝑃𝑟𝑜𝑝𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒(𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒) 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
dQ dP
eP = ( )÷(
Q 𝑃
𝑃𝑟𝑜𝑝𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒(𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒) 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑞𝑢𝑎𝑛𝑡𝑖𝑡𝑦 𝑑𝑒𝑚𝑎𝑛𝑑𝑒𝑑
eP = −
𝑃𝑟𝑜𝑝𝑟𝑡𝑖𝑜𝑛𝑎𝑡𝑒(𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒) 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑝𝑟𝑖𝑐𝑒
1.65 − 1.55
eP = − ( ) ÷ (−10 %)
1.55

eP = .645

The demand for the book is less elastic.

6. Price elasticity of demand for a wheat is unity. A family with 4 individuals demands 40 kg of wheat
per month when price is 25 per kg. What will be the price if wheat demanded by the family per month is
36 kg?

Solution:

Here,

Initial Price (P1) = Rs. 25 per kg of wheat

Initial Demand (Q1) = 40 kg
Final price (P2) = ?
Final Demand (Q2) = 36 kg

Given, Price Elasticity (ep) = 1

dQ P1
Or, – * =1
dP Q1

36  40 25
Or, – * =1
P2  25 40

Or, P2 = 27.5
8. Ramesh is a fruitarian. He spent his daily money income Rs 220 on apple and orange which are priced
at Rs.50 per unit and Rs.20 per unit respectively. Marginal utilities of both apple and orange obtained
by him are given bellow. Find out the optimal combination of the apple and orange. What is the maximum
utility obtained by Ramesh.

Quantity Consumed Marginal Utility of Apple Marginal utility of orange.

1 30 20
2 25 18
3 20 16
4 15 14
5 10 12
6 5 10
7 1 8

Solution:
Given, Price of Apple (PA)= Rs 50 unit
Price of Orange (P0) = Rs 20 per unit
Money income of Ramesh =Rs 220

MU of MU of Total Total Utility of

Quantity( Apple Orange( MUA/PA=50 MUO/PO=20 Utility of Orange
Q) (MUA) MUO) Apple
1 30 20 20
0.6 1 30
2 25 18 38
0.5 0.9 55
3 20 16 54
0.4 0.8 75
4 15 14 68
0.3 0.7 90
5 10 12 80
0.2 0.6 100
6 5 10 90
0.1 0.5 105
7 1 8 98
0.02 0.4 106

Ramesh will maximise satisfaction when

𝑀𝑈𝐴 𝑀𝑈𝑂
= = µ (Necessary condition)
𝑃𝐴 𝑃𝑂

Subject to constraint imposed by money income Y

Y =PAQA + POQO (sufficient condition)

(Both necessary and sufficient condition must be satisfied for the consumer to be in equilibrium.)

Here
𝑀𝑈𝐴 𝑀𝑈𝑂
= = µ = 0.6 𝑜𝑟 0.5 𝑜𝑟 0.4
𝑃𝐴 𝑃𝑂

However, when µ = 0.5,

Y (=220) = 50X2 + 20X6 =220

Thus, both necessary and sufficient conditions are satisfied.

The consumer, maximises satisfaction when µ = 0.5 where the optimum combination is 2 Apples and
6 oranges.

Maximum Satisfaction or utility obtained by Ramesh = Total Utility at 2 Apples

+
Total Utility at 6 oranges

= 55+90
=145

9. A consumer has Rs 22 which he spends on good X and Y at price Rs.5 and Rs.2 respectively. Total
utility obtained by him is given as follows. What is the maximum satisfaction obtained by him?

Quantity Consumed Total Utility of X Total Utility of Y

1 30 20
2 55 38
3 75 54
4 90 68
5 100 80
6 105 90
7 106 98

𝑀𝑈𝑋 𝑀𝑈𝑌
Hints: Find 𝑎𝑛𝑑
𝑃𝑋 𝑃𝑌

For Consumer’s equilibrium, the following conditions must be satisfied.

𝑀𝑈𝑋 𝑀𝑈𝑌
= = µ
𝑃𝑋 𝑃𝑌

Subject to constraint imposed by money income (Y)

Y =PXQX + PXQY

Hence the consumer will maximises satisfaction when µ = 5,

Where he will purchase 2 X and 6 Y.
Maximum Satisfaction or utility obtained = Total Utility at 2 X + Total Utility at 6Y = 145