IGCSE Economics Paper-2: Specimen Questions with Answers 87 - 88 of 100

Passage

Demand usually varies with price but the extent of variation is not uniform in all cases.

Question 87 (1 of 5 Based on Passage)

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What is the concept of cross elasticity of demand?

Explanation

The cross elasticity of demand refers to the degree of responsiveness of demand for a commodity to a given change in the price of some related commodity.

The cross elasticity of demand between any two goods X and Y is measured by dividing the proportionate change in quantity demanded of X by the proportionate change in the price of Y.

Thus,

The cross elasticity of demand measures the extent to which products are substitute or complimentary. A positive cross elasticity of demand indicates that the two products in consideration are substitutes, since an increase/decrease in the price of one cause an increase/decrease in the quantity demanded of other.

Concept of Elasticity

Question 88 (2 of 5 Based on Passage)

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Indicate the usefulness in classification of market situations.

Explanation

The concept of elasticity of demand has a wide range of practical application in economics and business.

  • To businessman: In decision making, the concept of elasticity of demand is of utmost importance, for taking decision for pricing policy, the businessman must know the likely effect of change in price on the product demand in the market. Like, he must consider whether a lowering of price will cause expansion in the demand for his product and if so to what extent and thus to what extent revenue would rise fetching what amount of profits.
  • To the government and finance minister: In determining the fiscal policy also, the concept of elasticity of demand is very important to the government. The finance minister must consider the elasticity of demand while selecting the commodities for taxation.

  • In International Trade: The concept is also useful in formulating export and import policies of the country. Further in determining different spheres of international trade, the relative elasticities of demand for commodities in two countries are very important.

  • To Policy makers: It is useful in solving the mystery of how farmers may remain poor despite a bumper crop. Since agricultural products, particularly food grains have inelastic demand, when there is a bumper crop it can be sold to only cutting prices substantially. Hence the total income of farmers will be lower despite bigger crop.

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