The price of a new toy increases from $5 to $7 and the quantity demanded decreases from 12,000 to 6,000 per month as a result. Based on this information, the price elasticity of demand (in absolute terms) is estimated to be equal to:
A)0.5, indicating relatively elastic demand.
B)0.5, indicating relatively inelastic demand.
C)2.0, indicating relatively elastic demand.
D)2.0, indicating relatively inelastic demand.

Question

The price of a new toy increases from $5 to $7 and the quantity demanded decreases from 12,000 to 6,000 per month as a result. Based on this information, the price elasticity of demand (in absolute terms) is estimated to be equal to:
A)​0.5, indicating relatively elastic demand.
B)​0.5, indicating relatively inelastic demand.
C)​2.0, indicating relatively elastic demand.
D)​2.0, indicating relatively inelastic demand.

Quizplus · Accepted Answer

Price elasticity of demand (PED) is measured as the percentage change in quantity demanded resulting from a one percent change in price.

In this case, the price increased by 40% (from $5 to $7), and the quantity demanded decreased by 50% (from 12,000 to 6,000).

PED is calculated as the percentage change in quantity demanded divided by the percentage change in price:

PED = (Δquantity demanded / average quantity demanded) / (Δprice /average price)

PED = ((6000-12000)/9000)/((7-5)/6) = -0.5/0.333 = -1.5

However, PED is always reported as a positive number. So, taking the absolute value, PED = 1.5.

Since the absolute value of PED is greater than 1, the demand is considered relatively elastic, meaning that consumers are very sensitive to changes in price. A 40% increase in price led to a 50% decrease in quantity demanded, which shows that the consumers are quite responsive to price changes.

Therefore, the correct choice is C) 2.0, indicating relatively elastic demand.

The Price of a New Toy Increases from $5 to $7