Question

Your friend owns a bakery and asks for advice. They increase the price of cakes from $12.00 to $15.00 and find that sales decline from 50 to 30, other things constant. • What is the price elasticity of demand? Is it elastic or inelastic? How might you explain this? What might you suggest regarding future price increases?

Answer 1

An elasticity of demand=(change in quantity/average quantity)/(change in price/average price)
Change in quantity=30-50=-20
average quantity=(30+50)/2=40
change in price=15-12=3
average price=(15+12)/2=13.5
Elasticity of demand=(-20/40)/(3/13.5)

=-2.25

=2.25 (absolute value)

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It is elastic as the elasticity is above 1 in absolute terms.

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How might you explain this?

The increase in price decreases revenue because the demand is elasticity in this range.

TR=P*Q

TR1=50*12=600

TR2=30*15=$450

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What might you suggest regarding future price increases?

To increase revenue, you should decrease price up to unit elastic demand but to increase product, you should compare the MR=MC where demand is elastic.