Question

1. How would the price elasticity equation apply to the purchase price of (a) gasoline, (b) an airline ticket, and (c) a checking account?

Give examples of situations that would affect this equation.

2. What would be your response to the statement, "profit maximization is the only legitimate pricing objective for the firm."?

3. A marketing manager reduced the price on a brand of cereal by 10 percent and observed a 25 percent increase in quantity sold. The manager then thought that if the price were reduced by another 20 percent, a 50 percent increase in quantity sold would occur. What would be your response to the marketing manager's reasoning?

Answer 1

1. How would the price elasticity equation apply to the purchase price of (a) gasoline, (b) an airline ticket, and (c) a checking account?

The price equation determines the degree of responsiveness of a quantity demanded of a good to its price. In other words, the price equation measures the percentage change in the quantity demanded of a good due to a one percent change in its price.

• Demand is elastic when a percent change in price causes quantity demanded to change by more than a percent.

• Demand is inelastic when a percent change in price causes quantity demanded to change by less than a percent.

• Demand is unit elastic when a percent change in price causes quantity demanded to change by one percent.

(a) Gasoline does not have any close substitutes that can be used in place of gasoline if its prices rise. Thus, gasoline is not much sensitive to price. It has relatively inelastic demand.

(b) An airline ticket is a luxury good. If the price of an airline ticket rises, the demand is likely to fall by a larger proportion. Airline ticket, therefore, are price-sensitive, and have relatively elastic demand.

(c) Maintaining a checking account is a necessity. If interest rate falls, it would not have much effect over the demand for checking accounts. Thus, checking account is not much sensitive to price. It has relatively inelastic demand.

2. What would be your response to the statement, "profit maximization is the only legitimate pricing objective for the firm."?

Profit maximization is not the only legitimate pricing objective for a firm. Although profit maximization is one of the most important objectives of a firm, it is not the only objective. An organization can have varying short-term and long-term goals depending upon the changing pattern of business cycle. Firms usually set a target return objective or a long-run profit goal. Firms also have certain non-profit goals such as unit sales objectives, market share objectives. Further, there are objectives influenced by the feelings of social responsibility. Such goals are also legitimate pricing objectives.

3. A marketing manager reduced the price on a brand of cereal by 10 percent and observed a 25 percent increase in quantity sold. The manager then thought that if the price were reduced by another 20 percent, a 50 percent increase in quantity sold would occur. What would be your response to the marketing manager's reasoning?

The marketing manager thinks that if the price cut on the cereal brand is doubled, the increase in quantity sold will also double. This would be situation if the individual’s demand curve for the cereal brand is a straight line. Moreover, the price elasticity of demand should also be constant throughout the curve. However, in reality individual demand curves are convex to the origin. The price elasticity of demand varies at different price levels along the demand curve.