Question

The CEO of Mainway Toys wants to increase total revenue for the firm and proposes a 10% decrease in the price of all toys.
a. The price elasticity of demand for toys is 2.5. Is the demand for toys price elastic, unit elastic, or price inelastic?
b. Will the CEO’s proposal to decrease all toy prices by 10% increase, decrease, or have no impact on total revenue for Mainway Toys? Explain.
c. Assuming the demand for Mainway Toys is linear, would further price decreases ever cause you to change your response in part (b)? Explain.

Answer 1

a. Demand for toys is price elastic as absolute value of price elasticity of demand is greater than 1.

b. As demand is elastic, so, a 10% decrease in price will increase quantity demanded by a greater proportion than 10%. Change in quantity demanded = 2.5*(10%) = 25%. So, quantity demande will increase by 25%. Thus, total revenue would increase as increase in quantity demanded is greater than decrease in price.

c. As the demand curve is linear, so, demand will become inelastic below the mid point of the demand curve. When demand becomes inelastic, decrease in price by 10% will lead to an increase in quantity demanded by less than 10% which would decrease the revenue. So, response in part b would change to decrease.