The price elasticity of banana
The price elasticity of bananas is -0.8 and the cross priceelasticity of bananas with respect tothe price of berries is 0.5. If the price of bananas increases by10 % and the price of berriesfalls by 4 %, what will happen to banana demand?a. A 10 percent increaseb. A 10 percent decreasec. A 16 percent increased. A 5 percent increasee. None of the above
Answer:
Price elasticity of demand is given by the followingformula:
Price elasticity of demand = % change in quantity demanded / %change in prices
On the other hand, Cross price elasticity of demand is givenas:
Cross price elasticity = % change in quantity demanded ProductA/ % change in the price of product B
Given that, Cross price elasticity of demand = 0.5 toberries.
Thus, 0.5 = % change in quantity demanded of banana / % changein price of berries
or 0.5 = % change in quantity demanded for banana / (-0.04)
or % change in quantity demanded for banana = -0.02 or 2%decrease in quantity demanded
Now, also given that price elasticity of banana = -0.8
Price elasticity = % change in quantity demanded / % change inprices
or (-0.8) = % change in quantity demanded / 0.1
or % change in quantity demanded = -0.08 or 8% decrease inquantity demanded
Thus, total change in quantity demanded for banana = -10%
or a 10% decrease in quantity demanded
Thus, Option B is the correct answer.
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