CFA Practice Question

There are 539 practice questions for this study session.

CFA Practice Question

The price elasticity of demand is a negative number. This means ______
A. demand is price elastic.
B. the demand curve is downward-sloping.
C. an increase in income will reduce the quantity demanded.
Explanation: This means that an increase in price leads to a fall in quantity demanded; the demand curve is downward-sloping. We cannot tell how responsive the quantity demanded from this, only that price and quantity demanded are inversely related.

User Comment
renataa why can we not answer A.? It is also a correct answer...
renataa I guess the question asks why it is the negative number. Its not because its elastic, because it is also elastic when its positive. But its negative because of the negative correlation of Price and quantity. I know its so confusing... Its almost unfair. It doesn't test our knowledge, its trying to trap us.
nzohoury @rentaa to know if you are at the elastic or inelastic part of demand curve you need to know the value not just the sign since the calculation is delta%Q/delta%P. All the sign tells you is the relationship between price and demand.

Here is an example where price elasticity of demand is negative at both an elastic and inelastic part of the demand curve:

Think of a gizmo with price elasticity of demand P=-50q+1,250

At \$1k each, you could sell only 5. To get to 6 sold (20% more) you only need to bring price to \$950 (5% less).

The price elasticity of demand for it is -4 (20%/-5%)

Now conversely at \$250 each, you can sell 20. To get to 21 (5% more), you need to lower price another \$50 (20% less)

The price elasticity of demand is now -0.25 (5%/-20%)

Essentially if your result is less than -1 (-2, -3, -4, etc.) that means small decrease in price % will result in large increase in demand % and you're in the elastic portion of the demand curve. If your result is greater than -1 (I.e a decimal since it'll never be 0) you're at the inelastic portion of demand curve.
nzohoury Minor correction, I was wrong in saying it'll never be zero. Price technically can be zero and even negative (when you give an incentive to someone to try your product) but those parts of the demand curve are particular to specific types of businesses (charities) or times in a product cycle (R&D)