CFA Practice Question

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CFA Practice Question

The current price of wheat is $1.00 per bushel and the price elasticity of demand for wheat is known to be 0.50. A bad harvest causes the supply of wheat to decrease, and as a result, the price of wheat rises by 20%. What will be the percentage change in the quantity of wheat demanded and will farm revenues rise or fall?
A. 10%; rise
B. 20%; fall
C. 10%; fall
Explanation: Elasticity of demand = (percentage change in quantity)/(percentage change in price). Thus, since elasticity is known to be 0.5, a 20% change in price must result in a 10% change in quantity demanded. Since demand is inelastic, a rise in price will cause total revenues to increase.

User Contributed Comments 4

User Comment
danlan Demand will decrease, but revenue rises by 10% because of the price change.
JepTang This could mean that the initial price and quantity demanded was not the equilibrium point yet as higher revenues was still recorded despite the shift in the supply curve.
DiscoAfro It seems that the question is stated incorrect. The elasticity must be negative! An increase in prices due to a drop in supply is only logical if the increase in prices causes a decrease in demand (to come in line with the decreased supply). Until so far a logical economical reaction. However the elasticity is stated as being positive, implying that an in crease in price will cause an increase in demand. This not logical due to the fact that the supply had decreased. This is confusing.
charlie for elasticity you should always treat it as a positive number. The sign does not matter.
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