Answer to Question #220466 in Microeconomics for Nitin Bhawani

Question

Q6:- A and B drive to a petrol pump. A says “I want 20 litres of petrol” and B says “I want Rs. 20/- worth of petrol”. What can you say about A and B’s price elasticity of demand on petrol?

□      Q7:- A firm increased the price of its product by 5.0 per cent and observed that its revenue increased by 3.0 per cent. Enthused by this fact, it again raised price by another 5.0 per cent. This time revenue fell by 8.0 per cent.

    How can one use the concept of elasticity to explain this be explained?

Answer 1

Q6:

A has a lower price elasticity of demand for petrol compared to B. That is, A’s demand for petrol is price inelastic while B’s demand for petrol is price elastic. A does not care about the price he will pay. What he cares most is 20 litres of petrol regardless of the price. On the contrary, B is particular about the amount he is ready to give to get the petrol. This shows that B is more sensitive to price change compared to A.

Q7:

This case shows that the price elasticity of demand for the firm’s product changes from being inelastic to elastic. A 5% increase in price leading to a 3% increase in revenue exhibits the product is price inelastic over a given price range. Normally, when a product is price inelastic, price and revenue are positively correlated. That is, an increase in the price increases the total revenue, and a decline in price reduces the total revenue. Thus, when the price was increased by 5%, the total revenue increased by 3% since the demand is inelastic. On the contrary, when the price was further increased by 5%, the demand became elastic since the product was pushed to a higher price segment. At a higher price, consumers are often sensitive to the price change, and thus the demand becomes elastic. When a product is demand elastic, the price and total revenue are negatively correlated. That is, an increase in price decreases total revenue, and a cut in price increases the total revenue.