Why does this simple price elasticity of demand question confuse me? Help.

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  • #3071961
    some_tear
    Participant

    Explanation highlighted below makes no sense. How they are going from 20% change in quantity demanded = (x units new – 5000 units old)/5000 units old to 4000 units???? Solving for x gives me 6000. Am I stupid?

    The price elasticity of demand for a good is 2.0, and the quantity demanded is 5,000 units. The price increases by 10 percent. What is the new quantity demanded?

    a.1,000

    b.4,000

    c.4,500

    d.6,000

    Answer:B

    Choice “b” is correct. The choice is derived from the following calculations:

    Price elasticity of demand = % Change in quantity demanded / % Change in price 2.0 (Given) = 20% (Solve) /10% (Given)% Change in quantity demanded (20%) = X units (new) – 5,000 units (old) 15,000 units (old) = 4,000 units

    #3072060
    RobOh
    Guest

    Don’t sweat it, that’s the great part about this forum. Their explanations are sometimes very convoluted. All you need is the below.

    20% / 10% = 2

    (5000 – 4000) / 5000 = 20%

    I hope that makes sense now. Sometimes we know the answer but don’t understand what they are asking. That’s why it’s so important that you keep practicing mcq’s over and over.

    #3072099
    RobOh
    Guest

    Sorry, I forgot to add that you should keep in mind that the quantity demanded would decrease if the price increases.

    #3074076
    some_tear
    Participant

    Sorry, I'm even more confused, especially about your formula for:

    (5000 – 4000) / 5000 = 20%. From what I understand, formula for change in quantity is…

    (New price – Old price) / Old price

    So how did you even derive that formula?

    #3074184
    RobOh
    Guest

    Ok, maybe this will make more sense.

    Price elasticity of demand = % change in quantity demanded / % change in price

    Given information:
    Price elasticity of demand = 2.0
    % change in demand = ?
    % change in price = 10%

    X / 10% = 2.0
    Therefore, X = 20%

    (New quantity – old quantity) / Old quantity = % change in quantity demanded

    If you apply the above formula:
    (4000 – 5000) / 5000 = 20%

    A new quantity of 6000 would also be 20%, however in this problem you would assume that the quantity demanded would decrease if the price increased.

    Try drawing it on a supply and demand curve and it may help you visualize it better. Any question that I had on the cpa exam I would always draw the supply and demand curve just to visualize and confirm that I was answering it correctly. Also think about what this is really trying to say, if the price of this good increases 10% then it would mean that the quantity would decrease 20%.

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