Question

A price change causes the quantity demanded for a good to increase by 20 percent and the total revenue of that good decreases by 15 percent. What can you say about the price elasticity of demand at this point.

		It's elastic
		It's inelastic
		It's unitary elastic
		It's perfectly elastic

Answer 1

Formula :

(i) TR(Total revenue) = P*Q, where P = price and Q = quantity

(ii) % change in (A*B) = % change in A + % change in B

Thus, % change in TR = % change in (P*Q) = % change in P + % change in Q

=> -15% = % change in P + 20% (Negative sign means that revenue decreases)

=> % change in P = -20% - 15% = -35%

Thua % change in Price = -30% (negative means that Price decreases)

Price elasticity of demand = % change in Quantity / % change in P = 20/(-35) = -0.57

Thus absilue value of price elasticity is lesser than 1. Hence Demand is inelastic

Hence, the correct answer is (b) It's inelastic.