b) Is it advisable for a coffe

b) Is it advisable for a coffee shop owner to increase the priceof his coffee if demand for coffee is price inelastic? Explainbriefly using a diagram that demonstrates the impact on the firm’sTotal Revenue.

c) Nicolas says that if income elasticity of demand for sugar is-0.7, sugar is an inferior good. Steve disagrees and claims that itis a necessity. Define income elasticity of demand and explain whois right and who is wrong with their statements above?

d) For Australian consumers of petrol, would the priceelasticity of demand be greater for Shell petrol or petrol ingeneral? Explain your reasoning


Part b)

Yes it is advisable for a coffee shop owner to increase theprice of his coffee if demand for coffee is price inelastic whichmeans that there are very few close substitutes for his coffee. Anyshop is concerned with total revenue and if the price elasticity ofdemand is inelastic, the total revenue increases as we increase theprice. That is, price increases and quantity decreases, but totalrevenue = price * quantity increases.

Part c)

Income elasticity of demand is defined as the percentage changein quantity demanded divided by the percentage change inincome.

Income elasticity of demand = (dQ/Q)/(dM/M) = (M/Q)*(dQ/dM)

If income elasticity of demand is negative (as is in -0.7) it isdeemed as an inferior good as we consume it less and less as incomerises. Necessary goods have income elasticity of demand between 0and 1. Hence Nicolas is right and Steve is wrong.

Part d)

The difference between Shell petrol and petrol in general isthat Shell petrol has only one manufacturer(Shell obviously) whilepetrol in general is produced by many oil companies around theworld. Hence we can say that there are many substitutes to Shellpetrol (that is petrol produced by other companies) but there arevery few substitutes to petrol in general (Substitutes includediesel, gasoline etc, but these aren’t perfect substitutes, eachhas its own different purpose).  

Hence we can say that price elasticity of demand is lesser( moreinelastic ) for petrol in general as compared to Shellpetrol(relatively elastic)

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