Question

Use the following information to answer the questions below.

Observation	Price	Quantity
A	$1.00	20
B	$2.00	15

1. Calculate a price elasticity of demand. You must show all your work to earn credit.

2. Given the elasticity of demand, a 10% increase in price will cause quantity demanded to fall by what percentage? Explain your answer.

3. Is this demand elastic or inelastic? Explain your answer.

Part II

Walmart advertises that it has rolled back prices. If Walmart is rolling back prices to raise revenues, should it roll back prices on products that have a price elasticity of demand that is elastic or inelastic. Explain your answer.

Answer 1

Part-I

Req 1:

Chnage in price: $2 - $1 = $1

Average price: (1+2)/2 = $1.5

% change in price: Change in price/ Average price = $1 / $1.5 *100 = 66.67%

Chnage in demand: 15-20 = -5

Average demand: (15+20)/2 = 17.5

% change in demand: Change in demand/ Average demand = -5 / 17.5 *100 = -28.57%

Price elasticity of demand: % change in demand/ % change in price = -28.57% /66.67% = - 0.43

Note: Price elasticity of demand is computed using Mid point method.

Req 2: Price elasticity= -0.43

% change in price = 10%

Price elasticity = % change in demand / % change in price

-0.43 = % change ind demand/ 10%

% chnage in demand = -4.3% (i.e. decrease by 4.3%)

Req3. Demand is inelastic.

Part II.

When price elasticity is elastic: The prices should be rolled back, as it will lead to increase in total revenue. when the demand of goods is elastic, the total revenue will rise with the decrease in prices.

When price elasticity is inelastic: The prices should not be rolled back, as it will lead to decrease in total revenue. In case of inelastic demand, the total revenue will bound to fall.