Suppose the demand for energy drinks decreases by 20% due to recent repercussions found in the consumption.If the supply elasticity is 1.2 and the demand elasticity is 0.80,the percentage change in the equilibrium price for energy drinks will:
A)rise by 0.1%.
B)fall by 0.1%.
C)rise by 10%.
D)fall by 10%.

Question

Quizplus · Accepted Answer

When demand decreases by 20%, it means the new quantity demanded is 0.8 times the original quantity demanded (100% - 20% = 80%). Therefore, the demand elasticity can be expressed as:

0.80 = % change in quantity demanded / 20%

% change in quantity demanded = -16%

The negative sign indicates that demand has decreased.

Using the supply elasticity formula:

% change in equilibrium price = % change in quantity supplied / supply elasticity

We need to find the % change in quantity supplied. Since the demand has decreased by 16%, there will be excess supply in the market, and suppliers will try to adjust by decreasing the quantity supplied. The exact decrease in quantity supplied will depend on the supply elasticity, which is given as 1.2. Assuming the supply curve is upward sloping (which is usually the case), the supply elasticity will be positive. This means that a 1% increase in price will lead to a more than 1% increase in quantity supplied (in absolute value). Therefore, a 1% decrease in price will lead to a more than 1% decrease in quantity supplied (in absolute value).

Assuming the supply elasticity is constant (which may not be exactly true, but a reasonable approximation), we can use the following formula:

% change in quantity supplied = -supply elasticity x % change in price

Plugging in the numbers:

-16% = -1.2 x % change in price

% change in price = 13.33%

The positive sign indicates that price has decreased, which is consistent with the law of demand. Therefore, the correct answer is D)fall by 10%.

Suppose the Demand for Energy Drinks Decreases by 20% Due