Question

1. If you cut the price of your good or service to increase the quantity demanded by your consumers, is that going to be a good thing for your firm? Discuss and justify your answer.
2. Consider two demand curves; on the left, demand for airline tickets by businesses, and, on the right, demand for airline tickets by vacationers. Let the initial price be $500 for each panel and let the price fall to $400. Choose a new quantity demanded for each panel and draw a demand curve to be clear about your intuition concerning the relative magnitude of the PED. Calculate the PED for each scenario and state and justify the magnitude of the PED.
3. Let the price of a live-saving AIDS drug by $10 per pill, and the quantity demanded is 40,000. An entrepreneur takes over the firm and increases the price to $5,000 per pill, and the quantity demanded is 40,000. Calculate the PED and describe your answer with a magnitude and justify your choice. Fully model this scenario, labeling total revenue both before and after the change in price. How do you feel about this business decision and why?

Answer 1

1) Law of demand says that there exist a negative relationship between price and quantity demanded. If reduce the price to sell more quantity to your consumers may not be good for firm because there could fall in total revenue from fall in price even if more units are sold. Producers have to estimate that if the demand for their product is elastic, they can reduce the price to raise revenue otherwise total revenue will fall in case of price fall of inelastic good.

2)

Elasticity of demand for businessmens is inelastic while on the other hand elasticity of demand consumers going on vacations would be elastic as they would change their quantity demanded when price rises while businessmen would not change that. As demand of businessmen is inelastic, fall in price from $500 to $400 will result in fall in total revenue because rise in quantity demanded would be a little in comparison to fall in price. Vacationers demand is elastic which means fall in price from $500 to $400 will raise total revenue because rise in quantity demanded would be much more than fall in price.

Elasticity of demand is calculated = %change in quantity demanded / %change in price

Elasticity of demand for businessmen = [(450 - 400) / 400] * 100 / [(500 - 400) / 500] * 100 = 0.625

Elasticity of demand for vacationers = [(600 - 400) / 400] * 100 / [(500 - 400) / 500] * 100 = 2.5

3)

Price of drug = $10

Quantity demanded = 40,000

Increase the price to 5,000 per pill

Quantity demanded is same as 40,000

Total revenue before price increase = 10 * 40,000 = 400,000

Total revenue after price increase = 5,000 * 40,000 = 200,000,000

Elasticity of demand is calculated = %change in quantity demanded / %change in price

Elasticity of demand = [(40,000 - 40,000) / 40,000] * 100 / [(5,000 - 10) / 10] * 100 = 0