Question

After graduating from college, you are hired by the Ford automobile company as an economic analyst. For your first project, you are asked to estimate what would happen to the sales of Ford Mustangs as a result of a change in (i) the price of a Chevrolet Camaro, (ii) the price of gasoline, and (iii) consumer incomes. You are given the following elasticities:

Price elasticity of demand for Ford Mustangs = -2.5
Cross-price elasticity between Ford Mustangs and Camaros = 1.5
Cross-price elasticity between Ford Mustangs and gasoline = -0.80
Income elasticity of demand for Ford Mustangs = 3.00
QUESTIONS:
1. Suppose the price of a Camaro falls by 10%. With all else being equal, sales of Ford Mustangs would Rise by __________.
2. If the price of gasoline increases by 20%, the quantity of Ford Mustangs would Fall by ________.
3. If consumer incomes increase by 5%, the quantity of Ford Mustangs would Rise by _________.

Answer 1

Explanation:Part 1). Answer :- Sales of Ford Mustangs will decrease by 15 % (1.5 * 10 %).

Explanation :- Camaro and Ford Mustangs are substitute goods because the cross-price elasticity between Ford Mustangs and Camaro is in positive. Accordingly, with the decrease in price of camaro, the quantity sold of Ford Mustangs will also decrease.

Part 2). Answer :- Quantity of Ford Mustangs will decrease by 16 % (0.80 * 20 %).

Explanation :- Gasoline and Ford Mustangs are complementary goods because the cross-price elasticity between Ford Mustangs and Camaro is in negative. Accordingly, with the increase in price of gasoline, the quantity sold of Ford Mustangs will decrease.

Part 3). Answer :- Quantity of Ford Mustangs will increase by 15 % (3 * 5 %).

Explanation :- With the increase in income of consumer, the demand for normal good also increase. Accordingly, with the increase in consumer's income, quantity demanded of Ford Mustangs will also increase.