If the quantity of new cars increases by 10 percent and the price elasticity of demand for new cars is 1.25, the price will fall by

• A. 8 percent
• B. 10 percent
• C. 2.5 percent
• D. 12.5 percent

Answer: (A)

Price elasticity of demand links how much quantity demanded responds to price changes: PED = (%ΔQd) / (%ΔP). Here the quantity of new cars increases by 10%, and the elasticity is 1.25. So 10% = 1.25 × (%ΔP). Solving gives %ΔP = 10% / 1.25 = 8%. Since quantity goes up, the price must fall, so the price change is -8%. This means the price will fall by 8%. (A quick check: -8% in price times 1.25 equals -10% in quantity, i.e., a 10% rise in quantity, matching the given change.)