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John Smith, C.E.O. of A.B.Co., is attempting to estimate the quantity of his product that will be demanded during April. At the current price of $20.00, A.B. Co. is selling 100,000 units per month. Mr. Smith has been informed that on April 1st, Delta Co., a producer of a substitute good, will be decreasing the price of its product by 10%. Given a cross elasticity of 2 and the following information, answer the following questions. For this problem, you may use the definition of elasticity to forecast quantity even.

MC = $4

Current Advertising Budget $200,000

A) How many units can Smith expect to sell during April, and by how much will his profits be affected? (4 points each)

B)  If Mr. Smith wants to maintain his current sales of 100,000 units, to what level should he change his price? (Assume Ep = -4) (3 points)

C) At this new price for his product profits will change by how much from part A? (4 points)

D) An alternative strategy for lowering his price to restore his sales volume to 100,000 units would be to increase advertising expenditures. Given an Advertising elasticity of 0.5. How much should advertising expenditures be changed to restore his sales to 100,000 units? (4 points)

E) Given your answer to D, what will be the change in his level of profits from part A? (3 points)

F) Which alternative would you favor if profit is the most important variable to Mr. Smith? (1 point)

NOTE: When you are asked to forecast a quantity resulting from a change in a variable, you may use the definition of elasticity, the easy method, to derive the forecast for all problems. Using the definition is less accurate than using the elasticity formula but much easier mathematically.

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Retselisitsoe Pokothoane
Retselisitsoe PokothoaneLv10
28 Sep 2019

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In 1981, a Boston-based gas station owner set the highest gasoline prices in the nation. During that summer, he charged $1.69 per gallon for unleaded gas during the daytime and $2.59 per gallon at night, when other downtown gas stations were closed. His all-time high price was $3.99. Even at these extreme prices, however, the station owner sold an average of 3,000 gallons per week, half of this at night. Despite catcalls, pickets, and even vandalism from angry motorists during the gasoline crisis, the owner "stuck by his pumps"; he even charged $1 for air. As he put it, "People think of gas stations as public mammary glands, but they're wrong. This is a business, and it's important to generate profits from every part of it. If I can use a resource, like air, to pay for the electric bill, so much the better. If you allow capitalism in its true form, it works beautifully".

The station owner was an avowed profit maximizer, albeit not a very attractive one. How did he profit from his dual-price policy? The answer is price discrimination. Although his costs varied little day and night, the elasticity of demand varied greatly. He maximized his profit by charging a higher price at night when demand is much more inelastic than during the day. In fact, we could go so far as to say that he operated under different market structures, day and night. At night, he appeared to have a pure local monopoly. Motorists desperate for gas had to drive miles to find another station open during those hours. Thus, the owner sold gas even at gouging prices. At those prices, the motorist may have preferred to buy five gallons rather than a full tank. During the day, he faced many competitors within blocks and numerous stations in neighboring Cambridge. That is, the market resembled monopolistic competition. There was some product differentiation due to locational convenience and brand allegiance. Nonetheless, in normal times excess profits are limited by the relatively free entry of new firms. (The gasoline crisis and accompanying supply shortage afforded sellers short-run, excess profits.)

A. Suppose that, during the day, the station owner's demand is given by PD = 2.06 - .00025QD. The marginal cost of selling gasoline is $1.31 per gallon. At his current $1.69 price, he sells 1,500 gallons per week. Is this price-output combination optimal? Explain.

B. The station owner sells an equal number of gallons at night, setting PN = $2.59. Suppose elasticity of demand is EP = -3. According to the optimal markup rule, is this price profit-maximizing?

As we have learned, many economic topics have been obsolete for decades. Yet, some topics and concepts continue to stand the test of time and are therefore useful today. Price point elasticity is a hallmark subtopic of microeconomics that is also considered a serious sub-topical contender for the modern body of knowledge surrounding our study of a sustainable economy. The reason for the legitimacy is that it based upon the mathematical ratio of price and quantity demanded along the demand curve. This basic calculation is in actuality a simple ratio that is based upon the linear slope relationship of price and quantity demanded for a specific product or service. Results render quantitative decision support for price adjustments and their consequence. For every one percent increase in price, the price point elasticity tells you how much less quantity will be demanded as a percent. Conversely, for every one percentage decrease in price, price point elasticity tells you how much more quantity will be demanded, as a percent.

Results are percentage so further calculation is needed to determine if the price adjustment is justified by a loss or gain relative to leaving the price the same. For example, the price demand schedule below says that for every one percent change we will see a two percent negative change in quantity demanded. So if we change the price five percent, we will see a negative impact of ten percent less product sold. If our product sells for $40 and we increase it to $42 we will see a drop of 200 sold. If the scale of our schedule is in millions sold, we will see a decrease of 200 million sold. Do you think it is worth the trouble of changing the price? Why?
We may gain $4000 by increasing price but we will also may lose 200 sales and at the new price of 42 dollars so our estimated loss of $8400 will be far greater than the gain. Of course, these are estimates and real world pricing may be in pennies instead of dollars, especially in this price range and other factors must be considered such as substitutes, complements, changing trends, taste, obsolesce, incomes, and a series of demographic fluctuations that are representative of the population of customers. Nonetheless, isolating price and quantity is the first exercise when considering the demand for a product or service.

Price Demand
50 1000
45 1500
40 2000
35 2500
30 3000
25 3500


Table 3 Price/demand schedule for some product or service

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