Q3Managerial Economics & Financial Accounting

Question

When the price of a commodity is Rs. 20 per unit, its quantity demanded is 800 units. When its price rises by Rs. 5 per unit, its quantity demanded falls by 20%. Calculate the price elasticity of demand. Is its demand elastic? Give reason for your answer.

Answer 1

Given Data: Initial Price ( $P_{1}$ ) = Rs. 20 Initial Quantity ( $Q_{1}$ ) = 800 units Change in Price ( $Δ P$ ) = + Rs. 5 (Price rises by 5) Percentage change in Quantity = - 20% (Falls by 20%)

Let's find the actual change in quantity ( $Δ Q$ ): $Δ Q = - 20% of 800 = - 160 units$

Formula for Elasticity: $E_{d} = \frac{Δ Q}{Δ P} \times \frac{P _{1}}{Q _{1}}$

$E_{d} = \frac{- 160}{5} \times \frac{20}{800}$ $E_{d} = - 32 \times \frac{1}{40} = - 0.8$

Ignoring the negative sign (which just denotes the inverse relationship), the elasticity is $0.8$ .

Reasoning: Since $E_{d} < 1$ , the demand is Relatively Inelastic. This is confirmed by the fact that a $25%$ increase in price (5 on 20) only led to a smaller $20%$ decrease in quantity demanded. The quantity response is weak.

Q3Managerial Economics & Financial Accounting

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