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. Based on your calculation, is the demand for milk sensitive to price or not sensitive to price Interpret the number you calculated for the elasticity of demand for milk. What docs that number meand. If the price of milk were to rise by 5%, how exactly would the quantity demanded change

Solution

(a)

Elasticity of demand = % Change in quantity demanded / % change in price

= [(720 - 760) / 760] / $[(4.6 - 4.2) / 4.2)]

= [- 40 / 760] / [0.4 / 4.2]

= - 0.0526 / 0.0952

= - 0.55

(b)

Demand is not highly sensitive to price because elasticity as an absolute value lower than 1 (inelastic demand).

(c)

Elasticity of - 0.55 means, if price increases (decreases) by 1%, quantity demanded decreases (increases) by 0.55%.

(d)

So if price increases by 5%, quantity demanded falls by (0.55 x 5) = 2.75%

(e)

Demand being inelastic, consumers will bear most of the excise tax.