Question

Let's say that a gasoline station discovers that it can sell 900 gallons of gasoline in one day when it charges $2.70, whereas it can sell 1,100 gallons in one day when it charges $2.50. What is the price elasticity of demand for gasoline for this gas station owner? If the owner's goal is to maximize revenue, do you recommend that this owner should lower the price to $2.50?

The price elasticity of demand is 2.6. The owner should lower the price in order to maximize revenue.

The price elasticity of demand is .38. The owner should not lower the price in order to maximize revenue.

The price elasticity of demand is .38. The owner should lower the price in order to maximize revenue.

The price elasticity of demand is 2.6. The owner should not lower the price in order to maximize revenue.

The price elasticity of demand is 10. The owner should not lower the price in order to maximize revenue.

The price elasticity of demand is .10. The owner should lower the price in order to maximize revenue.

Answer 1

Initial price (P1) = $2.70 per gallon

Initial quantity demanded (Q1) = 900 gallons

New price (P2) = $2.50 per gallon

New quantity demanded (Q2) = 1,000 gallons

Calculate the price elasticity of demand -

$Ed = \frac{\left ( Q2 - Q1 \right )}{\left ( Q2+Q1 \right )/2}\times \frac{\left ( P2+P1 \right )/2}{P2 - P1}$

$Ed = \frac{\left ( 900 - 1100 \right )}{\left ( 900+1100 \right )/2}\times \frac{\left ( 2.70+2.50 \right )/2}{2.70 - 2.50}$

$Ed = -2.6$

Thus,

The price elasticity of demand for gasoline for this gas station owner is 2.6

This means that the demand for gasoline for this gas station owner is elastic.

When the demand is elastic, decrease in price leads to an increase in the total revenue.

So,

The owner should lower the price in order to maximize the revenue.

Hence, the correct answer is the option (1) [The price elasticity of demand is 2.6, the owner should lower the price in order to maximize revenue].