Suppose that Bobo purchases 1 pizza per month when the price is $19 and 3 pizzas per month when the price is $15. What is the price elasticity of Bobo’s demand curve? Suppose
The Correct Answer and Explanation is :
To calculate the price elasticity of demand (PED), we use the following formula:
[
\text{PED} = \frac{\text{Percentage Change in Quantity Demanded}}{\text{Percentage Change in Price}}
]
Step 1: Calculate percentage change in quantity demanded
The quantity demanded changes from 1 pizza to 3 pizzas:
[
\text{Percentage Change in Quantity Demanded} = \frac{\text{New Quantity} – \text{Old Quantity}}{\text{Average Quantity}} \times 100
]
[
\text{Percentage Change in Quantity Demanded} = \frac{3 – 1}{\frac{3 + 1}{2}} \times 100 = \frac{2}{2} \times 100 = 100\%
]
Step 2: Calculate percentage change in price
The price changes from $19 to $15:
[
\text{Percentage Change in Price} = \frac{\text{Old Price} – \text{New Price}}{\text{Average Price}} \times 100
]
[
\text{Percentage Change in Price} = \frac{19 – 15}{\frac{19 + 15}{2}} \times 100 = \frac{4}{17} \times 100 \approx 23.53\%
]
Step 3: Calculate PED
[
\text{PED} = \frac{100}{23.53} \approx 4.25
]
Interpretation
The price elasticity of demand is approximately 4.25, which is highly elastic. This means Bobo’s demand for pizza is very responsive to changes in price. Specifically, a 1% decrease in price leads to a 4.25% increase in the quantity of pizzas demanded.
Explanation
Elastic demand indicates that substitutes, preferences, or budget considerations strongly affect purchasing behavior. When the price drops, Bobo significantly increases his pizza consumption, likely because the lower price makes pizza more appealing relative to other goods or within his budget. High elasticity suggests businesses need to carefully consider price changes, as small adjustments can lead to significant shifts in demand.