Question

You run the only lemonade stand in Central Park, New York City. If people don't buy lemonade from you, their only other option is to buy orange juice from a nearby vendor. One day, you decide to raise the price of your lemonade from $1 per glass to $1.25 per glass. As a result, half of your usual customers decide to get orange juice instead of lemonade that day.

a. What does this experience tell you about the demand for lemonade in Central Park?
b. Calculate the price elasticity of demand for your lemonade.
c. Draw the demand curve and supply curve for lemonade in Central Park illustrating the equilibrium both before and after your price change.
d. Now what would happen to Price and Quantities if the cost of lemons went up? (The market is for lemonade.)

Answer 1

1. The demand for lemonade is elastic since, the rise in price of lemonade led to the fall in the quantity demanded of the lemonade.

2. price elasticity of demand is given by = (dQ/dP)*(P/Q)

dQ= change in quantity demanded = Q/2

dP= 1.25-1 = 0.25

putting in the equation for price elasticity,

Price elasticity of demand = [(Q/2)/ 0.25]* [1/Q]

= 1/0.5 = 2

Thus, the price elasticity of demand for lemonade is 2, which is elastic.

3. The increase in price is shown by the movement along the demand curve below:

4. Since the lemons and lemonade are complements, an increase in cost of lemons would increase the cost of lemonade and thus, increasing the price of lemonade and reducing its supply. it would lead to a backward shift in the supply curve of lemonade.