QUESTION THREE [20 Marks]

a) Suppose the demand for good 𝐴 is given by 𝑄𝐴𝑑 = 500 − 10𝑃𝐴 + 2𝑃𝐵 + 0.70𝐼 where 𝑃𝐴 is
the price of good 𝐴, 𝑃𝐵 is the price of another good 𝐵, and 𝐼 is income. Assume that 𝑃𝐴 is
currently KES 10, 𝑃𝐵 is currently KES 5, and 𝐼 is currently KES 100.
i. What is the elasticity of demand for good 𝐴 with respect to the price of good 𝐴 at the
current situation ? [3 Marks]
ii. What is the cross-price elasticity of the demand for good 𝐴 with respect to the price
of good 𝐵 at the current situation ? [3 Marks]
iii. What is the income elasticity of demand for good 𝐴 at the current situation?[3 Marks]
b) A two-commodity market model is characterised by the following equations:
𝑄𝑑1 = 8 − 2𝑃1 + 𝑃2

𝑄𝑑2 = 20 + 2𝑃1 − 2𝑃2

𝑄𝑠1 = −6 + 8𝑃1

𝑄𝑆2 = −36 + 8𝑃2

iv. Use substitution method to derive equilibrium values of prices and quantities. [11
Marks]