Question

When the monthly average premium for life insurance was set at $100, 14,000 polices were sold. When premiums were raised to $150, monthly, only 8,000 polices were maintained.

a. What is the price elasticity of demand for life insurance in Nima?

b. State where the following state is True or False and explain your answer:

"All things equal, based on the price elasticity from a insurance companies must have recorded higher profits (than losses) as a result of the increased premiums."

Answer 1

a) Elasticity of demand is calculated as %change in quantity demanded / %change in price

%change in quantity demanded = [(8,000 - 14,000) / 14,000] * 100 = -42.85%

%change in price = [(150 - 100) / 100] * 100 = 50%

Elasticity of demand = -0.85

We can ignore the negative sign here because there always exist negative relationship between price and quantity demanded. Thus, elasticity of demand = 0.85

b) As elasticity of demans says that demand is inelastic, consumers must have reduced theie quantity demanded less than increase in price as consumers consider insurance as necessary good. Thus, this statement is true that this increase in price must have increased total revenue.