Question

Consider a retailer selling blenders currently priced at $54. Suppose it pays $29 per blender from the manufacturer.

(a) Suppose the retailer's market research team determines that the elasticity of demand for consumers of blenders is - 1.5. What does this imply about the actual demand for blenders in case of the two situations: a 33% price cut or a price increase to $59?

(b) Can you make recommendations to the retailer regarding which strategy makes more sense: a 33% price cut or a price rise to $59 from its current price level of $54?

Answer 1

Current profit per blender = $54 - $29 = $25

Price elasticity of demand is usually negative due to the inverse relation of price and demand. It is given by -

Price elasticity = %change in qty / %change in price

Or, %change in qty = %change in price x price elasticity

a) in case price is lowerd by 33%, qty should increase.

% change in qty = (-)33% x (-)1.5 = 49.5%

If the original qty is 100 units, then the new qty would be 149.50 units. New price would be 36.18. New profit per unit 7.18.

Old profit (100 units) = 25 x 100 = 2500

New profit (149.50 units) = 149.50 x (36.18 - 29) = 1073.41

Reduction in profit = (-)1426.59

Now, in case Price is increased, the quantity demanded should decrease.

%change in price = ($59-$54)/ $54 = 9.2593%

%change in qty = (-)1.5 x 9.2593% = (-)13.88895%

If the original qty is 100 units, new qty would be 86.11105 units.

New profit = 86.11105 x (59 -29) = 2583.3315

Increase in profit = 2583.3315 - 2500 = 83.3315

b) Increasing the price makes more sense as profit is increased slightly even though qty is reduced. When price is reduced by 33%, the increase in qty does not take care of the reduced price in terms of profit.