Question

A firm sells​ 3,000 headphones at a price of​ $3 per unit. Even though this price is slightly higher than competing​ brands, the management is considering a further increase in price by 25 cents. The firm plans to focus advertising efforts on superior sound clarity.​ Rachel, the​ firm's marketing​ head, feels confident that a price increase by 25 cents will increase revenue. Industry analysts are of the opinion that even though the revenue is likely to​ increase, the firm must be careful of rivals who are actively competing for higher market share.

a. Based on Rachel's assumption, would she think the price elasticity of demand for headphones is elastic, or inelastic?

The firm increased the price of headphones to​ $3.25 and the firm was able to sell 2,775 headphones at this new price.

b. What is the price elasticity of demand? Was Rachel's assumption correct?

Answer 1

A - Rachel thinks that the demand is inelastic in nature. That is why she is of the opinion that raising the price will increase revenue.

When the demand will be inelastic , the rise in price will lead to very small fall or no fall in demand. Hence the total revenue will rise as a result.

B -

Ed = % change in demand / % change in price

% change in demand = -225/3000*100

= -7.5 %

% change in price = 0.25/3*100

= 8.33 %

Ed = (-7.5)/8.33

= 0.90

Hence demand is inelastic in nature and Rachels assumption is correct.