Question

1. A local supermarket lowers the price of its T-bone steak from $6.00.lb to $5.00/lb. Sales increase by 15 percent. The store manager notices that chicken breast sales decrease by 10 percent. a. Calculate the arc price elasticity of T-bone steak. Explain what it means. b. Calculate the arc cross-price elasticity of chicken breast. Based on your calculation, chicken breast a substitute or complement? Why? c. Was the pricing decision good or bad for the supermarket? Explain. d. If you were to estimate a demand equation for T-bone steak, which variables would you choose as explanatory variables?

Answer 1

A local supermarket lowers the price of its T-bone steak from $6.00.lb to $5.00/lb. Sales increase by 15 percent. The store manager notices that chicken breast sales decrease by 10 percent.

a. Arc price elasticity of T-bone steak = % change in sales / % change in price = 15% / (5-6)*100/6 = -0.9. The price elasticity is less than 1 in absolute terms so demand is inelastic.

b. Arc cross-price elasticity of chicken breast = % change in sales Chicken breast / % change in price of T-bone steak = -10% / (5-6)*100/6 = 0.6. Since elasticity is positive, the two goods are substitutes.

c. The pricing decision was bad for the supermarket because demand is inelastic so a price reduction has reduced revenue.

d. An estimate of a demand equation for T-bone steak, depends on variables such as income of consumer, price of T-stone, advertising, price of substitutes such as chicken breast, price of complement etc