Question

Suppose the own price elasticity of demand for good X is −0.25, and the quantity of good X increases by 5 percent. What would you expect to happen to the total expenditures on good X? Please explain and show any calculations.

Answer 1

As per the information provided in the question

Own price elasticity of demand for Good-X= -0.25 (the negative sing indicates Good-X is a normal good and since 0.25<1, Price elasticity of demand for Good-X is less elastic)

Increase in quantity of Good-X =5%

As we know own price elasticity of demand method of estimation

Percentage change in quantity / Percentage change in price = price elasticity of demand

5 / Percentage change in price = -0.25   (Replacing the values)

5= -0.25x(Percentage change in price)

Percentage change in Price = 5/(-0.25)=-20   (Decrease in price by 20%)

With a 5% increase is quantity of Good-X resulted due to 20% fall in price

In other words 20% decrease in price of Good-X leads to increase in the quantity demand for Good-X by 5%

Though the price elasticity of demand for Good-X is less elastic; the change in price will results in change in total expenditure in the same direction. (Decrease in price of Good-X leads to decrease in Total expenditure for Good-X)

Therefore 20% decrease in price of Good-X leads to increase in the quantity demand for Good-X by 5%, and results in decrease in the total expenditure