Question

Please answer all questions, fill in table and show calculations.

The table below shows the hypothetical prices and quantities demanded of a software product. Assume that the fixed cost of setting up the production of software is $200 and the marginal cost is $5.

Fill out the table by calculating the revenue, the marginal revenue, total cost, the marginal cost, and the profit.

Give a general definition of price elasticity of demand. Explain the factors that make the demand of the product more elastic.

Calculate the own price elasticity of increasing the price from $0 to $5, from $5 to $10, etc., from $35 to $40. In which price region is the demand for the product elastic and in which region is it inelastic?

Conduct a stay even analysis by calculating the critical loss from increasing the price from $30 to $35. How much business can the software company afford to lose by increasing the price in order to maintain its profit?

Price   Quantity Sold   Revenue    Total Cost   MR     MC     Profit    Elasticity

40                0

35               10

30               20

25               30

20               40

15               50

10               60

5                 70

0                 80

Answer 1

Revenue is the product of price and quantity. Structure of total cost here is TC = FC + MC*Q or TC = 200 + 5Q. Profit is TR - TC and MR is found as TCn - TCn-1/ Qn - Qn-1

Price	Quantity	Revenue	Total cost	Profit	MR	MC
40	0	0	200	-200
35	10	350	250	100	35	5
30	20	600	300	300	25	5
25	30	750	350	400	15	5
20	40	800	400	400	5	5
15	50	750	450	300	-5	5
10	60	600	500	100	-15	5
5	70	350	550	-200	-25	5
0	80	0	600	-600	-35	5

The demand for a product gets influenced by its own price, income of the consumer and the availability of related goods. Note that price elasticity of demand articulates us the percentage change in quantity demanded for each 1 percent change in its own price. Similarly, income elasticity of demand indicates us the percentage change in quantity demanded for each 1 percent change in the income of the consumer.

Availability of close substitutes is a major determinant of price elasticity of demand, making it more elastic. With increased competition from incoming rivals, demand for the product will be more sensitive (or elastic). From the theory, it is known that when spending on a good makes up a larger proportion of family’s budget, the demand is more elastic. Similarly, demand for a broadly defined good is inelastic and for a narrowly defined good is relative elastic. In the short run, most goods are price inelastic.

Find the own price elasticity of increasing the price from $0 to $5, from $5 to $10, etc., from $35 to $40. Use the formula ed = % change in Qd/% change in price.

Price	Quantity	Elasticity
40	0
35	10	-7.00
30	20	-3.00
25	30	-1.67
20	40	-1.00
15	50	-0.60
10	60	-0.33
5	70	-0.14

See that absolute value of elasticity is smaller when the price is close to zero and it increases as price increases. Hence demand is unitary elastic at P = $20. For price $40 < P < $20 demand is elastic and |ed| > 1.  For price $20 < P < $0 demand isinelastic and |ed| < 1.

When we increase the price from $30 to $35, the profit is reduced from $300 to $100. Firm is earning a profit of $400 when it charges a price of $20 and produces 20 units where MR = MC. Firm should not increase the price when it lies in the elastic range of demand function. This will reduce its revenue and profit. Hence, there is a loss of $200 which the firm bears if it increases the price from $30 to $35.