Question

Suppose that when the price of ginger ale is $2 per bottle, firms can sell 4 million bottles. When the price of ginger ale is $3 per bottle, firms can sell 2 million bottles.
Which of the following statements is true?

a) The demand for ginger ale is income inelastic, so an increase in the price of ginger ale will increase the total revenue of ginger ale producers.
b) The demand for ginger ale is income elastic, so an increase in the price of ginger ale will increase the total revenue of ginger ale producers.
c) The demand for ginger ale is price inelastic, so an increase in the price of ginger ale will increase the total revenue of ginger ale producers.
d) The demand for ginger ale is price elastic, so an increase in the price of ginger ale will decrease the total revenue of ginger ale producers.

Answer 1

Solution: The correct answer is option D

Explanation:

The following formula is applied for calculating elasticity of demand:

$\mathrm{e}=\left[\left(\mathrm{Q}_{2}-\mathrm{Q}_{1}\right) /\left\{\left(\mathrm{Q}_{1}+\mathrm{Q}_{2}\right) / 2\right\}\right] /\left[\left(\mathrm{P}_{2}-\mathrm{P}_{1}\right) /\left\{\left(\mathrm{P}_{1}+\mathrm{P}_{2}\right) / 2\right\}\right]$

Here, Q2 = 2 million

Q1 = 4 million

P2 = $3

P1 = $2

$\begin{array}{l}\mathrm{e}=[(2-4) /\{(4+2) / 2\}] /[(\ 3-\ 2) /\{(\ 2+\ 3) / 2\}] \\\mathrm{e}=[(-2) / 3] /[1 / 2.50]\end{array}$

e = - 1.67

Thus, the absolute value is 1.67.

The ginger ale is price elastic because the absolute value is higher than 1. An increase in price will decrease its total revenue. Thus, the following statement is true:  (d) The demand for ginger ale is price elastic, so an increase in the price of ginger ale will decrease the total revenue of ginger ale producers.