Question

Finish the sentence: Price elasticity of demand at point A on Demand 1 implies that _______ 

a 10% increase in the price decreases the quantity demanded by 50% 

1% increase in the price decreases the quantity demanded by 0.05% 

a 10% increase in the price decreases the quantity demanded by 5% 

1% increase in the price decreases the quantity demanded by 0.5%

Answer 1

Elasticity of demand = (P/Q)(dQ/dP)

As demand is a straight line this means that dQ/dP is constant at every point.

Consider 2 points on this demand curve, (Q,P) = (0,12) and (6,0).

So, dQ/dP = Change in Q/Change in P = (6 - 0)/(0 - 12) = -0.5

At point A P = 10 and Q = 1

=> Elasticity of demand at point A on demand 1 = (P/Q)(dQ/dP) = (10/1)*-0.5 = -5

Thus elasticity of demand = -5. This means that 1% increase in price will result in decrease in quantity demand by 5% and so, increase in price by 10%, then demand will decrease by 50%. Thus option (a) is the correct answer

Hence, the correct answer is (a) a 10% increase in the price decreases the quantity demanded by 50%.