Suppose you manage a convenience mart and are in charge of ordering products but

Question

Suppose you manage a convenience mart and are in charge of ordering products but do not set the price. The home office provides the prices. In your area, the income elasticity of demand for peanut butter is -.05. Due to local factory closings, you expect local incomes to decrease by 20% on average in the next month. As a result, you should stock:

a) 20% more peanut butter on the shelves

b) 5% more peanut butter on the shelves

c) 10% more peanut butter on the shelves

d) 10% less peanut butter on the shelves

Explanation / Answer

Correct Answer:

1% more peanut butter should be kept on the shelves

Working Note:

Income elasticity of demand is - .05 (negative). It means that demand of peanut butter increases with decrease in income and vice versa.

Income elasticity of demand = Percentage change in demand / Percentage change in income

-.05=Percentage change in demand /(- .2)

Percentage change in demand = (- .2)*(-.05) = .01

Thus, demand will increase by only 1%. So, 1% more peanut butter should be kept on the shelves.

Note:

On the basis of given data in question, no optional answer is correct. If elasticity is -.5 then demand will increase by 10% and 10% more peanut butter will be kept on the shelves.

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