Question

You have determined that your firm’s own-price elasticity is -1.5 and that your firm’s cross-price elasticity with a competitor is 0.5. Last month your competitor increased prices by one percent. Today, in response, your manager has proposed also increasing prices by one percent. Your manager’s reasoning that by matching the competitor’s price increase, your firm will increase revenue. Would you support or refute your manager’s argument?           

Answer 1

No.

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Cross price elasticity of demand =%change in quantity of a good /%change in the price of substitute or complement

here the good s substitute as the cross price elasticity is positive.

using values

0.5=%change in quantity/1

%change in quantity=0.5*1=0.5%

the demand for your product increased by 0.5%

own price elasticity of demand =%change in quantity/%change in price

-1.5=%change in quantity/1

%change in quantity=-1.5 *1=1.5%

the quantity demanded decreases by 1.5%

total change in quantity=-1.5+0.5=-1%

the price increases by 1% but quantity decreases by 1% so there is no change in the revenue.

the demand is elastic at the price change so the increase in the price same as the competitor decreases your revenue or it may be same but your revenue will not increase.

the revenue will increase if the manager keeps price same.