If the quantity of new cars increases by 10 percent and the price elasticity of demand for new cars is 1.25, the price will fall by

If the quantity of new cars increases by 10 percent and the price elasticity of demand for new cars is 1.25, the price will fall by

• A. 8 percent
• B. 10 percent
• C. 2.5 percent
• D. 12.5 percent

Answer: (A)

Price elasticity of demand links how much quantity demanded responds to price changes: PED = (%ΔQd) / (%ΔP). Here the quantity of new cars increases by 10%, and the elasticity is 1.25. So 10% = 1.25 × (%ΔP). Solving gives %ΔP = 10% / 1.25 = 8%. Since quantity goes up, the price must fall, so the price change is -8%. This means the price will fall by 8%. (A quick check: -8% in price times 1.25 equals -10% in quantity, i.e., a 10% rise in quantity, matching the given change.)

Price elasticity of demand links how much quantity demanded responds to price changes: PED = (%ΔQd) / (%ΔP). Here the quantity of new cars increases by 10%, and the elasticity is 1.25. So 10% = 1.25 × (%ΔP). Solving gives %ΔP = 10% / 1.25 = 8%. Since quantity goes up, the price must fall, so the price change is -8%. This means the price will fall by 8%. (A quick check: -8% in price times 1.25 equals -10% in quantity, i.e., a 10% rise in quantity, matching the given change.)