Question

1. The demand for Peete’s coffee in Los Altos is such that at a price of $1.90 there is a quantity demanded of 155 cups per day. If the price is set at $2.10 then Qd falls to 145.

          - What is the price elasticity of demand over this range of prices?

          - If Peete’s is trying to maximize profits, should they raise the price to $2.10 (from $1.90)? Why? (note that profit = total revenues - total costs)

2. The price elasticity of demand for peanuts is 1.4. What does this mean?

3. What is the difference between price elasticity of demand and income elasticity of demand?

Answer 1

1.

The price elasticity of demand is calculated as below ,

PED= Percentage change in Qty demanded/ Percentage Change in price.

Initial Price (P_I) = 1.9, New Price (P_N) = 2.1,
Initial Quantity (Q_I) = 155, New Quantity (Q_N) = 145.

PED = ( (Q_N − Q_I) / (Q_N + Q_I) / 2 ) / ( (P_N - P_I) / (P_N + P_I) / 2 )

PED = ( (145 − 155) / (145 + 155) / 2) / ( (2.1 - 1.9) / (2.1 + 1.9) / 2)

PED = -0.0167 / 0.025

PED = -0.6667

Since |PED| < 1 ⇒ demand is inelastic.

The demand is here inelastic , means the quantity demanded changes less than proportionate to the changes in price so it will be a good idea to increase the price of the product to raise the total revenue. If the demand is inelastic , a price increase would cause an increase in total revenue.

2). If the value of the price elasticity of demand is greater than 1 we can say the demand is elastic, if the demand is elastic the quantity demanded changes more than proportionately to the change in price and at this condition the a price increase is not recommended.

3). The price elasticity of demand measures the responsiveness of quantity demanded to the changes in price while the income elasticity measures the responsiveness of quantity demanded to the changes in income.