Ahmed increases the price of his cakes from 80 to 100 dirham

Ahmed increases the price of his cakes from 80 to 100 dirhams per? cake, and his cash receipts decrease by? 2%. The price elasticity of demand is

A. elastic.

B. perfectly inelastic.

C. unit elastic.

D. inelastic

Solution

let assume that at 80 dirhams, ahmed was selling 1000 cakes, so his total cash receipt was 80000 dirhams (80*1000) now after change in price his receipts decreased by 2% i.e. 80000-2%(80000) = 78400 dirhams, and new quantity will be 78400/100 = 784 cakes

price elasticity = % change in quantity / % change in price.
change in price = 20/80*100 =25%
change in quantity = - 216/1000*100 = - 21.6%

elasticity = - 21.6% / 25% = - 0.864

elasticity is less than 1 and we can see that change in demand is less than change in price.
hence price elasticity of demand is
D. inelastic

dear student,

assumption in above answer will not effect final answer, because we are only concerned about % change in demand and price, but not actual price and quantity.

hope it helped.

good luck.