The short-run elasticity of demand for gasoline sold at gasoline stations is 0.20. If terrorism causes the supply of gasoline to fall, resulting in a 5 percent drop in quantity, and other things remain the same, the price per gallon will increase by:
A) 4 percent.
B) 5 percent.
C) 20 percent.
D) 25 percent.

Question

Quizplus · Accepted Answer

The price elasticity of demand formula is: % change in quantity demanded = elasticity * % change in price. Rearranging gives % change in price = % change in quantity demanded / elasticity. With a 5% drop in quantity and elasticity of 0.20, the price increase is 5% / 0.20 = 25%.

The Short-Run Elasticity of Demand for Gasoline Sold at Gasoline