Economics – The allocation of resources - Price elasticity of demand (PED) | e-Consult
The allocation of resources - Price elasticity of demand (PED) (1 questions)
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Explanation: A PED of -2 indicates that demand is elastic. This means that a 10% increase in price will lead to a proportionally larger decrease in the quantity demanded. Therefore, the firm's total revenue will fall.
Calculations:
- Calculate the percentage change in quantity demanded: Since PED = (% change in quantity demanded) / (% change in price), we can rearrange to find the percentage change in quantity demanded: % change in quantity demanded = PED * % change in price = -2 * 10% = -20%. This means the quantity demanded will decrease by 20%.
- Assume an initial quantity and price: Let's assume the initial quantity sold is 1000 phones at a price of £50 each. The initial total revenue is 1000 * £50 = £50,000.
- Calculate the new quantity demanded: A 20% decrease in quantity demanded means the new quantity sold is 1000 - (20% of 1000) = 1000 - 200 = 800 phones.
- Calculate the new price: The price is increased by 10%, so the new price is £50 + (10% of £50) = £50 + £5 = £55.
- Calculate the new total revenue: The new total revenue is 800 * £55 = £44,000.
- Calculate the percentage change in total revenue: % change in total revenue = ((New Total Revenue - Initial Total Revenue) / Initial Total Revenue) * 100 = ((£44,000 - £50,000) / £50,000) * 100 = (-£6,000 / £50,000) * 100 = -12%.
Conclusion: The firm's total revenue is expected to decrease by 12% as a result of the price increase, due to the elastic demand.