Question

QUESTION 4

(a) If the price of a good increase from $3.50 to $4.25, leading to a fall in quantity demanded from 25 to 15 units, what is the price elasticity of demand for the good at this price range?

Interpret the value.

(b) Explain why it is important for the business owner to understand the meaning of the             elasticity value.              

Answer 1

a)

Price elasticity of demand (mid point) = (P1 + P2)/(Q1 + Q2) x (Q2 - Q1)/(P2 - P1)

PE = (3.5 + 4.25)/(25 + 15) x (15 - 25)/(4.25 - 3.5) = -2.583

This means that for every 1% change in price level quantity demanded would decrease by 2.583%

b)

Understanding of the elasticity would help the business owner to gauge the effect of price change on the total revenue as any change in price level is related to the change in quantity demanded (Total revenue = Price x Quantity). Thus, it would help him in making pricing decisions so as to increase total revenue and maximize profit.