If a 10% increase in price causes a 15% drop quanity demanded of a particular good, What is the price elasticity of demand
The correct answer and explanation is:
Correct Answer:
The price elasticity of demand (PED) is -1.5.
Explanation:
Price elasticity of demand measures how much the quantity demanded of a good responds to a change in its price. It is calculated using the formula: Price Elasticity of Demand (PED)=% change in quantity demanded% change in price\text{Price Elasticity of Demand (PED)} = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}
In this case, the percentage change in price is +10% and the percentage change in quantity demanded is -15%. Substituting into the formula: PED=−15%+10%=−1.5\text{PED} = \frac{-15\%}{+10\%} = -1.5
The negative sign reflects the inverse relationship between price and quantity demanded. When price goes up, demand usually goes down, which is a normal behavior in most markets. The absolute value of PED helps classify the good:
- If the absolute value is greater than 1, demand is elastic
- If it equals 1, demand is unit elastic
- If it is less than 1, demand is inelastic
Since the absolute value of -1.5 is greater than 1, the demand for this good is elastic. This means consumers are highly responsive to price changes. A small increase in price leads to a proportionally larger decrease in quantity demanded. This sensitivity might be because the good is not a necessity, has many substitutes, or represents a significant part of a consumer’s budget.
Understanding the elasticity helps businesses and policymakers. If the goal is to increase revenue, raising prices on elastic goods can backfire, since the fall in quantity demanded may outweigh the higher price. Instead, lowering prices might actually increase total revenue by boosting sales volume.