Suppose that when the price of milk rises from 420 to 460 pe

Suppose that when the price of milk rises from $4.20 to $4.60 per gallon, the quantity demanded falls from 760 to 720 gallons. Compute the elasticity of demand for milk below. (2) Based on your calculation, is the demand for milk sensitive to price or not sensitive to price? Explain. (2) Interpret the number you calculated for the elasticity of demand for milk. What does that number mean? (2) If the price of milk were to rise by 5%, how exactly would the quantity demanded change? Compute below. (2) If the government placed an excise tax on milk, who would pay the majority of the tax, milk producers or milk consumers? Explain verbally. (2)

Solution

(a)

Elasticity - % Change in quantity demanded / % change in price

=(Change in Q/ Change in P)*(P/Q)

=-(-40/.40)*(4.2/760)

=0.553

(b)

Given the price elasticity of demand less than 1, the demand is less sensitive to the price of the commodity

(c)

An elasticity of 0.55 means that a 1% (Rise / Fall) change in the price of the commodity will result in 0.553% (Fall/Rise) change in demand for the commodity.

(d)

E = % Change in quantity demanded / % change in price

0.553 = % Change in quantity demanded / 5 = 2.763158% fall in the demand for milk