Suppose that OPEC currently sets the oil price at $1.50 per gallon, and the current consumption is 100 million gallons per day. The price elasticity of demand for oil is estimated to be 0.7 by the initial value method. If OPEC raises the oil price to $1.80 per gallon
A) quantity demanded decreases by 10 million gallons while total sales revenue increases by $4.4 million per day.
B) quantity demanded decreases by 14 million gallons while total sales revenue increases by $4.8 million per day.
C) quantity demanded decreases by 10 million gallons and total sales revenue decreases by $4.4 million per day.
D) quantity demanded decreases by 14 million gallons and total sales revenue decreases by $4.8 million per day.

Question

Quizplus · Accepted Answer

Using the initial value method, we can calculate the price elasticity of demand as:

E = (% change in quantity demanded) / (% change in price)

We know that the current price is $1.50 per gallon and the current consumption is 100 million gallons per day. If OPEC raises the price to $1.80 per gallon, there is a 20 cent increase in price, or a 13.3% increase. Using the price elasticity of demand, we can calculate the expected decrease in quantity demanded:

0.7 = (% change in quantity demanded) / 13.3%

% change in quantity demanded = 9.31%

Quantity demanded decreases by:

9.31% of 100 million gallons = 9.31 million gallons

Now we can calculate the expected change in total sales revenue:

Initial revenue = $1.50/gallon x 100 million gallons = $150 million/day

New revenue = $1.80/gallon x 90.69 million gallons = $163.24 million/day

Change in revenue = $163.24 million/day - $150 million/day = $13.24 million/day

So total sales revenue increases by $13.24 million per day, or $4.8 million if we round to the nearest tenth of a million.

Therefore, the best choice is B: quantity demanded decreases by 14 million gallons while total sales revenue increases by $4.8 million per day.

Suppose That OPEC Currently Sets the Oil Price at $1