Question

The current price foor in the wrotural lettuce market makes it such that the price of w eis 25% higher ante u much would neveu x change for the lettuce company if the government removed the current c oor? m price and that 100 heads of leucere demanded. Assuming that the castity of Grand for lettuces -050. how OA Revenue will decrease by $15.50 OB Revenue will increase by $15.00 Oc. Revenue will increase by $40.00 OD. Ravenue will increase by 1.40

Answer 1

Solution:

Firstly, note that price elasticity of demand is -0.5, which is lower than 1 in absolute terms, meaning that demand for lettuce is inelastic. In such case, since quantity demanded is little impacted by price change, price and total revenue move in the same direction. With removal of price floor (which was at price level higher than equilibrium price), the price will decrease, and so the total revenue will decrease as well (we already know our correct option, let's dig in a bit more).

Price elasticity of demand = percentage change in quantity/percentage change in price

So, percentage change in quantity = price elasticity*percentage change in price

Percentage change in quantity = -0.5*-25% = 0.125 or 12.5%

Then, new demand of lettuce (post removal of price floor) = initial demand*(1 + percentage change)

= 100*(1 + 0.125) = 112.5

Then, say if initial price of lettuce was $1, initial total revenue = 1*100 = $100

With changes, price = (-25*1/100 + 1) = $0.75, and demand of 112.5, new revenue = 0.75*112.5 = $84.375

Then change in revenue = 84.375 - 100 = -$15.625

Thus, correct option is (A).