Association of Chartered Certified Accountants (ACCA) Certification Practice Test

Which equation best determines the price elasticity of demand?

1. Price change ÷ quantity demanded

2. Percentage change in quantity demanded ÷ percentage change in price

3. Quantity supplied ÷ price change

4. Average demand ÷ total revenue

The correct answer is: Percentage change in quantity demanded ÷ percentage change in price

The price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. This concept is essential for understanding consumer behavior and market dynamics. The correct equation for determining the price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. This formula captures both the magnitude of the change in quantity demanded and the context of the price change, making it a relative measure. By using percentage changes, the equation allows for comparison across different goods and price levels, providing a more accurate understanding of how demand responds to price fluctuations. The result indicates whether demand is elastic (responsive to price changes) or inelastic (less responsive), which is crucial information for businesses and policymakers. The other options do not effectively measure price elasticity. For instance, the first choice focuses on absolute changes rather than percentages, which lacks the necessary context to understand elasticity. The third option mistakenly mixes concepts related to supply rather than demand, and the last option does not relate directly to the elasticity of demand but rather to demand in relation to revenue. Thus, only the percentage change in quantity demanded divided by the percentage change in price accurately defines price elasticity of demand.