hey guys These might be stupid questions but any help will be appreciated. 1. why does elasticity fall as price falls and quantity demanded rises? 2.X has a cross price elasticity with Y which is equal to unity..the solution says X is an imperfect substitute of Y..n just why is that????..I doubt if this is directly mentioned in the core reading.. thanks in advance!
1. Price elasticity of demand is calculated as: (Change in QD / Original QD) divided by (Change in price / Original price) Take a small enough change in quantity and price, so that they are negligible and the above is approximated by Original price / Original QD. So as price falls (or QD rises), elasticity will fall. 2. Substitute goods tend to have a positive cross price elasticity of demand (Chapter 3, P14), so the answer is either Option A or B. You're right that perfect substitutes/complements aren't mentioned in the Core Reading, but we can work it out by thinking of examples. If goods are perfect substitutes then the (rational) consumer will be indifferent between the two goods and so will choose the cheapest, for example black and blue staplers. So if the price of one good increases, then there will be no demand for it as all consumers will choose the other good. Perfect substitutes will therefore have a cross price elasticity of demand of infinity. So the answer is Option B.
Alternatively The elasticity equation is[ (Change in OQD)/OQD]/[(Change in P)/P] (OQD is original quantity demanded and P is price) This can be rearranged giving [(change in OQD)/(change in P)] * (P/OQD) Mathematically we know that (change in OD)/(change in P) is the inverse of the gradient at a point on the Demand curve. For a straight line graph it is a constant. Therefore the part which affects elasticity for a straight line demand curve is the (P/OD) part. As price falls and quantity demanded increases the numerator decreases and the denominator increases resulting in the fraction (P/OD) getting smaller. This results in the elasticity decreasing.
