Page 58 - DECO101_MICRO_ECONOMICS_ENGLISH

Unit 4: Elasticity of Demand

If X and Y (say butter and bread) are complements, e will be negative. If the price of bread rose Notes
c
(assuming that all other factors are held constant), there would be a decrease in the quantity
demanded of bread and a decrease in the quantity demanded of butter. Thus, for complements,
a change in price of one good causes the quantity demanded of the complements to move in the
opposite direction (assuming that all other factors are held constant).
If there is a percentage increase in the price of bread, the denominator in the formula would be
positive. Similarly, if there is a percentage decrease in the quantity of butter, the numerator in the
formula would be negative. Hence, e is negative for complements.
c
If X and Y (say tea and coffee) are substitutes, e will be positive. If the price of coffee rose
c
(assuming that all other factors are held constant), there would be a decrease in the quantity
demanded of coffee and an increase in the quantity demanded of tea as consumers would readily
“substitute” tea for coffee. Thus, for substitutes the price change of one good (assuming that all
other factors are held constant) causes the quantity demanded of the substitute to move in the
same direction. If there is a percentage increase in the price of coffee, the denominator in the
formula would be positive. Similarly, if there is a percentage increase in the quantity demanded
of tea, the numerator in the formula would be positive. Hence, e is positive for substitutes.
c
The higher the numerical magnitude of cross elasticity, the greater is the degree of complementarity/
substitution between the two goods. Thus, theoretically the value of cross elasticity ranges from
minus infi nity (– ∞) for perfect complements to plus infi nity (+∞) for perfect substitutes.
dQ x dP x
e = ÷
c Q x P x
dQ P
= x × x
dP Q
x x

Case Study Student’s Dilemma

small state university is faced with a critical financial problem. At present tuition
rates, the university is loosing ` 5 crores per year. The head of the university urges
A that there should be a 25% increase in tuition fee. Based on the total students
enrolled, he projects that this increase would cover the ` 5 crores deficit in revenues.

Student leaders protest but it falls on deaf ears. Students realise that their only hope is to
demonstrate that the tuition hike is not in the best interest of the university. What can they
do?

Students find a journal article that discusses the price elasticity of demand for college
education. The author estimates that the elasticity of enrollment at state universities is –1.3
with respect to tuition charges. That is, a 1% increase in tuition would decrease enrollments
by 1.3%. The data are current. Based on the elasticity estimate, the students calculate that
the proposed tuition hike of 25% would decrease enrollment by 32.5%. This would result
in a decrease in total revenue even after tuition increase.
The university is given this information and it is forced to withdraw its proposed hike and

find alternative ways to meet the defi cit.
Question
Evaluate the ultimate decision of the university to withdraw the proposed hike.
Source: Atmanand, Managerial Economics, 2nd Edition, Excel Books.

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