Question

Insta Print offers same-day developing services for all types of film. The firm’s Chicago franchise processed 1,500 packages of the film last month when it charged a price of $5.00 per package. The national company has embarked on an ambitious plan to increase sales by cutting prices to $4.75 per package. Monthly sales rose to 1,750 at the Chicago franchise. Each package of film requires $1.50 in paper and chemicals and takes 20 minutes of labor time. Insta Print pays its employees $6.00 an hour. Labor and materials (paper and chemicals) are the only variable costs associated with film processing.

a. Compute and interpret the arc price elasticity of demand for film processing.

b. What is the profit-maximizing markup on film processing? What price should the firm charge?

Answer 1

a) Arc price elasticity of demand: percentage change in quantity/percentage change in price:

%Change in quantity=1750-1500/1500 = 0.166

%Change in price= 4.75-5/5 = -0.05

elasticity= -3.3333

It means that a unit fall in price leads to 3.34 unit increase in quantity demanded.

b) Profit maximizing markup on film processing can be fund out by inverse elasticity rule: P-MC/P=(1/-e), where P is price charged, MC is marginal cost to firm and e is elasticity of demand.

MC= cost of paper and labor required to make an extra film= $1.5+$2(1 hr labor cost is $6, so 20 mins cost of labor would be 6/3)= $3.5

putting all values in equation, we get= P-3.5/P= 1/3.3333. After basic algebra, we will get P=$5