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If the price elasticity of demand for a product is 2.5, then a price cut from $2.00 to...

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esther77 | (Level 1) Honors

Posted May 6, 2013 at 4:18 AM via web

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If the price elasticity of demand for a product is 2.5, then a price cut from $2.00 to $1.80 will:

a)   Increased the quantity demanded by about 2.5 percent

b)   Decreased the quantity demanded by about 2.5 percent

c)   Increased the quantity demanded by about 25%

d)   Increased the quantity demanded by about 250%

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted May 6, 2013 at 4:54 AM (Answer #1)

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The correct answer to this is C.  This change in price should lead to a 25% increase in quantity demanded. 

In order to understand why this is so, let us start with the equation for finding the elasticity coefficient.  That equation is:

Elasticity coefficient = percentage change in quantity demanded / percentage change in price

We are already given the elasticity coefficient so we know that

2.5 = percentage change in quantity demanded / percentage change in price

Furthermore, we know how much the price has changed.  We know that the price was originally $2 and it dropped to $1.80.  That is a 20 cent drop on an original price of $2.00.  20/200 = .1 so the percentage change in price is 10 (because the price dropped by 10 percent).

We are now left with the equation:

2.5 = percentage change in quantity demanded / 10

Using algebra, we multiply both sides by 10.  That gives us 25% = percentage change in quantity demanded.

Thus, we can see that C is the correct answer.  The drop in price leads to a 25% change in quantity demanded.

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