Assuming elasticity is reported in absolute value, a measured price elasticity of demand of 1.2 would indicate:
A. an elastic demand, meaning the percentage change in quantity demanded will be greater than the percentage change in price.
B. an inelastic demand, meaning the percentage change in quantity demanded will be greater than the percentage change in price.
C. an elastic demand, meaning the percentage change in quantity demanded will be less than the percentage change in price.
D. an inelastic demand, meaning the percentage change in quantity demanded will be less than the percentage change in price.
The correct answer and explanation is :
Correct Answer: A. an elastic demand, meaning the percentage change in quantity demanded will be greater than the percentage change in price.
Explanation (Approximately 300 words):
Price elasticity of demand (PED) measures how responsive the quantity demanded of a good is to a change in its price. It is calculated using the formula:
$$
\text{Price Elasticity of Demand} = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}
$$
Elasticity values are often reported as absolute values (ignoring the negative sign that comes from the law of demand), and they are interpreted as follows:
- Elastic demand occurs when the absolute value of elasticity is greater than 1. This means that consumers respond significantly to price changes.
- Unit elastic demand occurs when the absolute value equals 1, meaning the percentage change in quantity demanded equals the percentage change in price.
- Inelastic demand occurs when the absolute value is less than 1, indicating a relatively unresponsive change in quantity demanded compared to the change in price.
In this case, the measured elasticity is 1.2, which is greater than 1. Therefore, demand is elastic. This implies that a 1% decrease in price will lead to more than a 1% increase in quantity demanded, or vice versa. Consumers are relatively sensitive to changes in price, which might happen with luxury goods, non-essential items, or goods with many substitutes.
Since elasticity reflects consumer responsiveness, businesses use this information to decide on pricing strategies. If a product has elastic demand, lowering prices might increase total revenue because the increase in quantity demanded will more than make up for the lower price.
So, Option A is correct: an elasticity of 1.2 indicates elastic demand, where the percentage change in quantity demanded exceeds the percentage change in price.