Suppose the value of the price elasticity of demand is -3. What does this indicate about consumer response to price changes?

• A. A 1% increase in price leads to a 3% decrease in quantity demanded.
• B. A 3% increase in price leads to a 1% decrease in quantity demanded.
• C. Demand is perfectly inelastic.
• D. Consumers do not respond to price changes.

Answer: (A)

Verified step by step guidance

1. Recall the definition of price elasticity of demand, which measures the responsiveness of quantity demanded to a change in price. It is given by the formula: \[\text{Price Elasticity of Demand} = \frac{\% \text{ change in quantity demanded}}{\% \text{ change in price}}\]
2. Note that the price elasticity of demand is given as -3. The negative sign indicates the inverse relationship between price and quantity demanded, which is typical for most goods (as price increases, quantity demanded decreases).
3. Interpret the magnitude of the elasticity: an elasticity of -3 means that for every 1% increase in price, the quantity demanded changes by 3% in the opposite direction (decreases in this case).
4. Use the elasticity formula to express this relationship: If \(\% \Delta P = +1\%\), then \[\% \Delta Q = \text{Elasticity} \times \% \Delta P = -3 \times 1\% = -3\%\]
5. Conclude that a price elasticity of -3 indicates consumers are quite responsive to price changes, with a 1% increase in price leading to a 3% decrease in quantity demanded.