Question

A. The price of good A has recently increased by 7 percent. As a result, the quantity demanded has decreased by 3 percent.

1. Is the demand for good A elastic or inelastic? Explain why.

2. Does good A likely have many substitutes or only a few substitutes?
Explain why.

3. As a business manager, how would knowing the price elasticity of demand
for your firm's products help you determine the prices of the products?
_____________________________________________________________


B. If an individual was required to take a specific drug (like insulin) to maintain a basic quality of life, the demand for this drug would likely be very inelastic. If the price for a month's supply of this drug increased by several thousand dollars, would the demand remain inelastic? Why or why not?

Answer 1

(A)

(1) Price elasticity of demand = % Change in quantity demanded / % Change in price

= -3% / 7%

= - 0.43

Since absolute value of elasticity is less than 1, demand is inelastic.

(2) The lower (higher) the elasticity of demand, the less (more) the number of substitutes. An inelastic demand signifies the good has less substitutes available, so buyers are less price-sensitive.

(3) When demand is inelastic, a rise (fall) in price will increase (decrease) the total revenue. Therefore in order to increase revenue, the firm should increase its price.

(B)

Demand will remain inelastic even when price rises. The reason is that the drug is a necessity life-saving good for the consumer, and its quantity demanded does not depend on its price.