If a 10 percent cut in price causes a 15 percent increase in sales, then
The correct answer and explanation is:
Correct Answer:
The demand is elastic, because the percentage increase in sales (15%) is greater than the percentage decrease in price (10%).
Explanation:
Price elasticity of demand measures how sensitive the quantity demanded of a good is to a change in its price. It is calculated using the following formula:
Price Elasticity of Demand (PED) = (% Change in Quantity Demanded) / (% Change in Price)
In this scenario, the price decreases by 10 percent and the quantity demanded increases by 15 percent. Plugging these numbers into the formula:
PED = 15% / 10% = 1.5
When the absolute value of PED is greater than 1, demand is considered elastic. This means consumers are relatively responsive to changes in price. In such a case, a small decrease in price leads to a proportionally larger increase in the quantity sold. This behavior usually occurs for goods that are not necessities or for those that have many substitutes.
Elastic demand implies that reducing the price leads to a rise in total revenue. This is because the extra units sold more than compensate for the lower price per unit. Businesses often examine this type of elasticity when deciding whether to lower prices to increase sales volume.
Goods such as luxury items, non-essential consumer products, or products with many alternatives tend to exhibit elastic demand. In contrast, necessities like fuel, salt, or medication often show inelastic demand, where changes in price lead to smaller changes in the quantity demanded.
Therefore, since a 10 percent cut in price results in a 15 percent rise in sales, the demand for the product is elastic. The business will likely see an increase in total revenue due to this pricing strategy.