A firm has estimated the following demand function for its product : Q=58 - 2 P + 0.10 I + 15 A Where Q is quantity demanded per month in thousands , P is product price , I is an index of consumer income , and A is advertising expenditures per month in thousands . Assume that P = $ 10 , I = 120 , and A = 10 . Use the point formulas to complete the elasticity calculations indicated below . ( i ) Calculate quantity demanded . ( ii ) Calculate the price elasticity of demand . Is demand elastic , inelastic , or unit elastic ? ( iii ) Calculate the income elasticity of demand . Is the good normal or inferior ? Is it a necessity or a luxury ? ( iv ) Calculate the advertising elasticity of demand .

Answer

( i ) Q = 58 - ( 2 ) ( 10 ) + ( 0.10 ) ( 120 ) + ( 15 ) ( 10 ) = 200 ( ii ) ( - 2 ) ( 10/200 ) = - 0.10 so demand is inelastic ( iii ) ( 0.10 ) ( 120/200 ) = 0.06 so the good is normal and a necessity ( iv ) ( 15 ) ( 10/200 ) = 0.75

Based on the information and calculations above (Question 22: A firm has estimated the following demand function for its product: Q = 400 - 5 P + 5 I + 10 A,where Q is quantity demanded per month in thousands, P is product price, I is an index of consumer income, and A is advertising expenditures per month in thousands. Assume that P = $200, I = 100, and A = 20.)

If the firm decides to raise the price by 2% in the coming year, accompanied by a 1% increase in advertising expenditures. Consumer income is expected to increase by 2% next year. How should the firm adjust the production (Q)?