What situation is occuring if a 1 percent decrease in price results in more than a 1 percent increase in quantity demanded?
A Demand is price elastic.
B Demand maintains the status quo.
B Demand results in the income effect.
C Demand is price inelastic.
D Demand is cross-price elastic.
The correct answer and explanation is:
The correct answer is A: Demand is price elastic.
When the price of a good or service decreases by 1 percent and this leads to more than a 1 percent increase in the quantity demanded, the demand is considered price elastic. Price elasticity of demand refers to how sensitive the quantity demanded is to changes in price. Specifically, if the percentage change in quantity demanded is greater than the percentage change in price, demand is elastic.
In this case, the percentage increase in quantity demanded is greater than the percentage decrease in price, which indicates that consumers are very responsive to the price change. This usually occurs for goods or services that have readily available substitutes, where a price drop encourages consumers to buy more of the cheaper alternative. The elasticity coefficient, which is calculated by dividing the percentage change in quantity demanded by the percentage change in price, would be greater than 1, confirming that the demand is elastic.
When demand is elastic, businesses may lower their prices to increase sales, knowing that the volume of additional sales will more than compensate for the lower price. Examples of products with elastic demand include many non-essential consumer goods, such as electronics or luxury items. Conversely, if demand is inelastic, a price decrease would not result in a significant increase in quantity demanded.
Understanding price elasticity is crucial for both businesses and policymakers because it helps them predict how changes in price will affect demand and, by extension, revenue. Products with elastic demand are highly sensitive to price changes, while inelastic products are less affected by price changes.