Question

Notice that there are multiple things to solve within the question

4. Given the demand for Milk is Qp = 500 - P, calculate the own-price arc elasticity of demand from a price change of $1.25 to $1.50. How would you characterize the demand for milk over that range (in economic terms) and what does this imply for total expenditures on milk given a price change?

Answer 1

Demand is Q_d = 500-P

When P = $1.25 , Q_d = 500-1.25 = 498.75, Total expenditure = $1.25*498.75 = $623.44

When P = $1.50 , Q_d = 500-1.50 = 498.50 , Total expenditure = $1.50*498.50 = $747.75

Then, Percentage change in P = (1.50-1.25)/1.25 * 100 = 20%

and Percentage change in Q_d = (498.50-498.75)/498.75 * 100 = -0.05%

Then, own-price elasticity of demand = Percentage change in Q_d/Percentage change in P

or, own-price elasticity of demand = -0.05/20

or, own-price elasticity of demand = -0.0025

As the own-price elasticity of demand is close to 0, demand curve for milk is perfectly inelastic. Here, we can see, there is a significant increase in total expenditure (from $623.44 to $747.75) within this price range.