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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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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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