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IAI Actuarial Core Principles · Business Economics · How competitive markets operate

The price of a particular health insurance rider rises from Rs 2,000 to Rs 2,200 per year. As a result, the number of policies sold falls from 10,000 to 9,000. Using the simple percentage-change method (change divided by the original value), what is the price elasticity of demand (in absolute value) and how is demand classified?

The price elasticity of demand is 1.0, so demand is unit elastic. Quantity falls by 10 per cent, from 10,000 to 9,000, while price rises by 10 per cent, from Rs 2,000 to Rs 2,200. Dividing 10 by 10 gives one.

  1. A0.5, inelastic
  2. B1.0, unit elasticCorrect
  3. C2.0, elastic
  4. D0.1, inelastic
  5. 10.0, elastic

Explanation

Percentage change in quantity = -1,000/10,000 = -10%. Percentage change in price = 200/2,000 = +10%. Elasticity = 10/10 = 1, so demand is unit elastic. The figure 0.5 would come from halving the quantity change by mistake, and 2.0 from inverting or doubling the ratio.

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