Question

1) Suppose Ed=0.5 for a given good. If there's a 5% change in price, what is the change in quantity demanded (Qd)? and Suppose once again that E=0.5, but there's now a 15% change in price (all else equal). Calculate the change in quantity demanded.

2) Briefly explain how total revenue (TR) will be affected in each of the following cases (use the TR formula):

a) Demand is elastic and price increases

b) The price elasticity of demand (Ed)= 0.7 and price increases

c) demand is elastic and price decreases

d) demand is perfectly inelastic (Ed=0) and price increases

e) demand is inelastic and price decreases

Answer 1

1.

Since the elasticity of demand can be defined as the measurement of the degree of the responsiveness of the quantity demand due to the change in the price level

a.

Ed = % change in the quantity demand of good X/ % change in the price of good X

If % change in the price=5%

0.5=% change in the quantity demand of good X/ 5%

% change in the quantity demanded=0.5*5%

= -2.5%

If % change in the price=15%

0.5=% change in the quantity demand of good X/ 15%

% change in the quantity demanded=0.5*15%

= -7.5%

2.

a) Demand is elastic and price increases

TR=P*Q

Since demand is elastic and when price increases, the quantity demand decrease in greater quantity. Hence TR decreases.

b) The price elasticity of demand (Ed)= 0.7 and price increases

Since Ed=0.7 which is less than 1, hence the demand is inelastic.

When price increases but quantity demand decreases in less quantity. Hence TR will increase.

c) demand is elastic and price decreases

Since demand is elastic and price decreases, quantity demand increases in greater quantity. Hence TR will increase.

d) demand is perfectly inelastic (Ed=0) and price increases

Due to increase in the price, the quantity demand is unaffected. Hence TR will increase.

e) demand is inelastic and price decreases

Since demand is inelastic, so with the decrease in the price, the quantity demand is less responsive due change in the price. Hence TR will decrease.