Theory question 101
ElasticityA dealer in deep freezers increased the price of his product from $450 to $500 and sales dropped from 800 units to 600 units a week. Use the information above to answer the questions that follow.
(a) (i) Calculate the price elasticity of demand. (ii) What type of elasticity is it? Explain your answer.
(b) Calculate the: (i) total revenue of the company before and after the price increase; (ii) change in total revenue.
(c) What is the effect of the increase in price on the total revenue?
(d) State two factors influencing price elasticity of demand.
Show the model answer
(a)(i) % change in quantity = (600 − 800)/800 × 100 = −25%; % change in price = (500 − 450)/450 × 100 = 11.1%; Ed = 25 ÷ 11.1 ≈ 2.25 (ignoring the minus sign)
(ii) Elastic demand, because the coefficient is greater than 1: quantity fell by a bigger percentage than price rose.
(b)(i) Before: 450 × 800 = $360,000; after: 500 × 600 = $300,000
(ii) Change = 300,000 − 360,000 = −$60,000 (a fall of $60,000)
(c) Total revenue fell, because demand is elastic.
(d) Any two: availability of substitutes; whether the good is a necessity or luxury; proportion of income spent on it; number of uses; habit; time period; durability.
With elastic demand, raising price reduces total revenue.