Suppose you own a sandwich shop with fixed costs of $1,000/month and marginal costs of $2.00/sandwich....

Suppose you own a sandwich shop with fixed costs of $1,000/month and marginal costs of $2.00/sandwich. If the price is $6/sandwich, 500 sandwiches are sold. If the price is $4.50/sandwich, 800 sandwiches are sold.

A) Use these figures to calculate the price elasticity.

B) Calculate the profits and profit margins (profit/total cost) associated with the price at $6/sandwich and at $4.50/sandwich. Given these calculations, what price should you charge for sandwiches?

Expert Solution

A) Use these figures to calculate the price elasticity.

As price and demand are inversely related, the elasticity will always be negative so it is reported in absolute terms only without the minus sign so it is 1.62

B) Fixed cost is $1000 or the cost that is incurred when output = 0

Now we have to calculate the Profit margin

As profit is the same in either situation, it is better to sell more and generate higher total revenue. This is because the fixed cost remains constant so total cost goes on decreasing, leading to a higher profit margin at higher output.

Rahul Sunny answered 8 months ago

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