Question

For the first time in two years, Big G (the cereal division of General Mills) raised cereal prices by $\mathbf{4}$percent. If, as a result of this price increase, the volume of all cereal sold by Big G dropped by $\mathbf{5}$percent, what can you infer about the own price elasticity of demand for Big G cereal? Can you predict whether revenues on sales of its Lucky Charms brand increased or decreased? Explain.

Short answer

The demand is inelastic. So, it follows that price reduction will yield a greater revenue because of the increased demand.

Step-by-step solution

Find the elasticity of demand

The elasticity of demand is defined as the ratio of the percentage change in demand with the percentage change in price.

$\mathrm{E}=\frac{\mathrm{\%}{\mathrm{\Delta Q}}_{\mathrm{x}}^{\mathrm{d}}}{\mathrm{\%}{\mathrm{\Delta P}}_{\mathrm{x}}}$

Calculation

According to the task we have,

$\mathrm{\%}{\mathrm{\Delta Q}}_{\mathrm{x}}^{\mathrm{d}}=-5$

$\mathrm{\%}{\mathrm{\Delta P}}_{\mathrm{x}}=4$

By substituting the values we will get,

$\begin{array}{c}\mathrm{E}=\frac{\mathrm{\%}{\mathrm{\Delta Q}}_{\mathrm{x}}^{\mathrm{d}}}{\mathrm{\%}{\mathrm{\Delta P}}_{\mathrm{x}}}\\ =\frac{-5}{4}\\ =-1.25\end{array}$

Here, the elasticity is negative.,$-\mathrm{\infty }<-1.25<-1$

Therefore, the elasticity is inelastic.

It shows that price reduction will yield higher revenue because of the increased demand.