Suppose that an increase in the price of a good from 4 to 5

Suppose that an increase in the price of a good from $4 to $5 causes the quantity demanded of the good to fall from 95 to 85.

3.1 What is the price elasticity of demand of the good when price changes from $4 to $5?

3.2 When the price of the good changes from $4 to $5, does the total revenue increase or decrease?

3.3 By how much does the total revenue increase or decrease?

3.4 Assume the price elasticity of demand of the good is 2 when the price changes from $4 to $5. If the price rises fro $4 to $5, then how will the total revenue change, increase or decrease?

Solution

Ans)

3.1
Price elasticity= % change in quantity demanded/ % change in price

% change in quantity demanded= (Q2-Q1)/Q1 * 100
=(85-95)/85*100
=-10.52
% change in price=(P2-P1)/P1*100
=(5-4)/4*100
=25
Price elasticity=-10.52/25=-0.42%

3.2
The total revenue will increase this is because the price elasticity is less than zero or inelastic.

3.3
Total revenue 1= Price * Quantity
=4*95
=380
Total revenue 2=5*85=425

increase in total revenue==TR2-TR1
=425-380
=45

3.4

The total revenue will decrease this is because the price elasticity is more than zero or elastic.