Question

Suppose you are advising an industry association on the predicted effects of a price change on quantity demanded and total expenditure on their product. The current price is $1.00 per unit, and quantity demanded is 2,500 units per day. Based on extensive empirical studies, you know that price elasticity of demand for the product is -0.5. If the price increases to $2.00 per unit:

5.1 What is the predicted percentage change in quantity demanded?

5.2 Will total expenditure increase or decrease?

Answer 1

5.1

% change in price = (2-1 / 1)*100 = 100%

Elasticity of Demand = % change in quantity demanded / % change in price

-0.5 = % change in quantity demanded / 100

% change in quantity demanded = -50%

So, the quantity demanded would fall by 50%

5.2

Since the elasticity is < 1, the demand is inelastic. In case of inelastic demand, there exists a direct relationship between price and total expenditure.

So, an increase in price will lead to a rise in the total expenditure.