Suppose there was a 4% decrease in the price of a good, and as a result, the expenditure on the good increased by 2%. What can you say about the elasticity of demand?
When the price of a good decreases by 4% and the expenditure on the good increases by 2%, the expenditure changes in the opposite direction as the price change. According to the relationship between elasticity and expenditure, this happens if and only if the percentage change in quantity is greater than the percentage change in price. This means the good is price-elastic (elasticity greater than 1).
Therefore, we can conclude that the elasticity of demand is greater than 1 (in absolute terms). The demand for this good is elastic, meaning consumers are highly responsive to price changes.
Explanation
The textbook establishes a clear relationship between price changes, expenditure changes, and elasticity. When expenditure moves in the opposite direction of price (price falls, expenditure rises), it indicates that the percentage change in quantity demanded exceeds the percentage change in price. This is the defining characteristic of elastic demand (|Ed| > 1). The numerical values (4% price decrease, 2% expenditure increase) confirm this relationship, though the key insight is simply the opposite directional movement of price and expenditure.
Solution Steps
Step 1: Identify that price decreased (4%) while expenditure increased (2%) - they move in opposite directions.
Step 2: Apply the rule from the context: expenditure changes in the opposite direction as price change if and only if the good is price-elastic.
Step 3: Conclude that elasticity of demand is greater than 1 (elastic demand).