1 – Elasticity Using Linear Demand:

Assume that the demand for product X is represented by the following equation:

QDX=1000-10PX-5PY+2PZ

i) Calculate the elasticity of demand if Px = 20 Py = 30 and Pz = 50.

ii) Based on your calculation what type of a G/S is it? Explain.

iii) Calculate the cross price elasticity of demand for Good Z and Good X only.

iv) Interpret the value of the cross price elasticity of demand and determine what type of G/S good Z is relative to good X. Explain.

2. Budget Line:

Over the past decade medical costs have increased more rapidly than other prices. In order to illustrate how rising medical costs have affected consumer alternatives, let X represent the quantity of medical services, and let Y represent the quantity of other goods. Furthermore, let income (M) be measured in hundreds of dollars, the price of medical services and other goods in terms of dollars per minute, with M=1000, Px=20, and Py=5.

Note: In general we may note that w ≥Px*X + Py*Y à use M instead of W for the purposes of this question.

i. Graph the budget line, and determine the market rate of substitution. Make sure to Illustrate the budget set as well as what is unaffordable. Also note the maximum amounts of medical G/S and other G/S you can purchase given wealth and prices.

ii. Show in your graph what happens to the budget constraint if Px increases to $40 (i.e. the costs of medical services increase).

iii. What is the meaning of the slope of the two budget constraints? Explain using the values you calculated.