Question

Alice’s hair salon increased its total monthly revenue from RM10,000 to RM15,000 when it raised the price of hair cut from RM50 to RM60.

a. Calculate the price elasticity of demand for Alice’s hair salon.

b. Suppose you are the hair salon’s consultant, if Alice wish to increase her revenue, would you advise her to continue with her existing plan?

Answer 1

Ans) a) To calculate price elasticity of demand,

Formula:-

Price elasticity (Ed) =

percentage change in quantity demanded (Q)/ percentage change in price (P)

which will be:-

Ed = ∆Q/Q ÷ ∆P/P

Ed = ∆Q/Q × P/∆P

Here ∆Q is difference between changed and original quantity demanded; and

∆P is difference between changed and original price

To find the quantity demanded,

Formula:-

Total revenue= Price × Quantity demanded

Therefore, Quantity demanded= Total revenue/ Price

Thus, originally:-

Q1 = 10,000/ 50 = 200

And changed:-

Q2 = 15,000/ 60 = 250

Thus, to find price elasticity of demand for Alice's hair salon:-

∆Q = Q2 - Q1 = 250- 200

∆Q= 50

∆P = Changed price (P2) - Original price (P1)

∆P = 60- 50 = 10 RM

Ed = 50/200 ÷ 10/50

Ed = 50/200 × 50/10

Ed = 1.25

b) Yes, if Alice wishes to increase her revenue, she should continue with her existing plan. This is because when we calculated the price elasticity of demand for Alice's hair salon, we found that the price elasticity of demand is greater than 1 which means that the demand is relatively elastic demand.

As the price of the hair cuts increase from RM50 to RM60 the revenue also increases from RM10,000 to RM15,000. On calculation we observe that the demand increases too from 200 to 250 which results in the price elasticity of demand to be greater than 1 i.e. 1.25.

This shows that the plan adopted by Alice is a good one and will result in increase in her revenue without resulting in any decrease in demand for her salon.