If the demand elasticity is more than 1 in absolute value and the supply decreases, which of the following statements is true?
A. Revenue for the firm increases.
B. Revenue for the firm decreases.
C. Revenue for the firm remains unchanged.
D. Revenue for the firm increases by 25%.
E. We need more information to determine what happens to revenues.
The Elasticity of Demand:
The price elasticity of demand refers to how the buyers are sensitive to a change in the price of a good or service. We calculate it by dividing the percentage change in the quantity purchased by the percentage change in the price. If the calculated elasticity is greater than 1, we say that the demand is elastic and when it is less than 1, we say that the demand is inelastic.
Answer and Explanation: 1
The correct answer is: B. Revenue for the firm decreases.
A decrease in supply means that the supply curve will shift to the left, and the equilibrium price will rise. Given that the demand is elastic, the increase in price will reduce the firm's revenue.
When the demand is elastic, total revenue changes in the opposite direction of a change in price, and when the demand is inelastic, the change in the total revenue moves in the same direction of change in price.
Learn more about this topic:
fromChapter 3 / Lesson 7
Understand what elasticity of demand is and discover different types of elasticity of demand. Learn how it is measured and review the elasticity of demand formula.