Question

The price of gasoline is $2.00 and the price elasticity of demand is -0.4.

a)How much will a 10% reduction in quantity placed on the market increase the price?

b) If -0.4 is a short run elasticity, do you expect that this price increase brought about by this reduction in quantity will be more of less in the long run? Why?

Show work.

Answer 1

a)The price of gasoline= $2.00

Price elasticity of demand =-0.4

The quantity gets reduced by 10 %

Suppose the quantity demanded initially was X units

When the quantity gets reduced by 10 %, the change in quantity becomes 10/100*X= -0.1X

Substituting in the formula,-0.4= (Change in quantity demanded/change in P)*(Price/Quantity)=(-0.1X/Change in P)*(2.00/X)

On solving this we get the change in /increase in price to be 0.5 $ per unit of the quantity demanded

b) The price increase brought about in the long run will be more than that was brought about in the short run. Initially the decrease in the quantity demanded will increase the price only by a smaller percentage.This is because consumers take time to respond to changes in price. They take time to change their shopping habits. Thus demand tends to be more elastic in the long run than in the short run.