Question

3. A company has calculated their point price elasticity of demand to be -0.8 when they sell 6,000 units a month at a price of $120 per unit.

3. (a) The CEO is planning to implement an aggressive price cut in order to increase the quantity sold and, therefore, the revenue of the company. What would be your feedback on such plan? Justify your answer using the economic intuition behind the concept of price elasticity of demand.

(b) What is the expected percentage change in the monthly quantity of units sold if the company raises the price by 30%? How many monthly units do they expect to sell after this change in price? Calculate price elasticity of demand at the new price and quantity.

(c) What should be the price in order to sell 7,200 units?

(d) The production manager informs the CEO of the company they just discovered a new and cheaper way to produce the good they sell. His advice is to double production because the new procedure halves the cost per unit, so costs will remain unchanged. Should the recommendation be followed? Relate your answer to the concept of elasticity.

Answer 1

[Answer 3A]

My feedback would be not to go for an aggressive price cut to sell more. This is because our product has got a relatively inelastic demand (<1). This means that the % change in quantity demanded will be less than % change in price. This intuitively means that with a substantial reduction in price %, we can only increase the demand by a % which is less than the reduction in price %. Thus, the aggressive price cut may not work well for an inelastic demand.

[Answer 3B]

The Expected Percentage Change in Quantity on account of increasing Price by 30% would be (-)24%.

The company expects to sell 4560 units after its rise in price. The Elasticity remains 0.8.

The entire working has been shown below.

[Answer 3C]

To sell 7200 units, the price needs to be fixed at $90.

The working has been shown below.

[Answer 3D]

No, the recommendation should not be followed to increase company sales or profitability. In terms of elasticity, we can expect sales to increase by about 40%, which is less than the price cut of 50%. This firm's profitability may get hampered if this decision of using the new technique is taken. This happens because despite doubling production rates, the increase in sales would be less than double. Due to relatively inelastic demand, company cannot sell as much even despite reducing the price drastically.