Question

The price of oil is $30 per barrel and the price elasticity is constant and equal to -0.5. An oil embargo reduces the quantity available by 20 percent. Use the arc elasticity formula to calculate the percentage increase in the price of oil.

Answer 1

Solution.

Initial price $P_0=30$

Price elasticity $E_p=-0.5$

Change in quantity $=20\%=0.2$

New price

$P_1=30\times(1+\frac{0.2}{|-0.5|})$

$P_1=30\times 1.4 =42$

Percentage change in price

$=(\dfrac{42-30}{30})\times 100$

$=40\%$