Problem
You work for Starbucks and know the following elasticities:
η= 1.2 η I = 2 η xy1 = 0.4 η xy2 = -0.6
η is the price elasticity of demand for a Starbucks Tall Caramel Macchiato, ηxy1 is the cross elasticity of demand between a Starbucks Tall Caramel Macchiato and Java City's Large Caramel Javalanche, ηxy2 is the cross elasticity of demand between a Starbucks Tall Caramel Macchiato and a Starbucks blueberry muffin, and η I is the income elasticity of a Starbucks Tall Caramel Macchiato.
i. If the manager wants to increase his sales of Tall Caramel Macchiato by 6%, in what direction and by how much does he need to change the price?
ii. If the manager makes the percentage price change that you calculated in part i) will total revenue increase or decrease? How do you know?
iii. Starbucks raises its price of a Tall Caramel Macchiato by 10%. The demand for Starbucks blueberry muffins will change by what percentage and in what direction?
iv. Java City lowers the price of its Large Caramel Javalanche by 5%. The demand for Starbucks' Tall Caramel Macchiato will change by what percentage and in what direction?
v. If average income increases by 3% by what percentage and in what direction will the demand for Starbucks' Tall Caramel Macchiato change? Is a Tall Caramel Macchiato a normal good or an inferior good and how do you know?