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 2,769 headphones at this new price.
b. What is the price elasticity of demand? Was Rachel's assumption correct?
The headphoes demand in the market is inelastic as the quantity purchased after the increase of 25 cents cause the decrease in 231 units of headphones but the revenue of the firm did not decrese however it did not increase a bit due to price hike. The comment on increase in revenue was wrong as Rachel thought that a price increase by 25 cents will increase revenue but after the price hike th erevenue decreased by 75 cents.
The price elasticity of demand measures the effect on demand due to change in price of a good or service.
Q0 = 3000 P0 = 3.00
Q1 = 2769 P1 = 3.25
Price elasticity = ((Q1-Q0)/Q0)/((P1-P0)P0)100 = (231/3000)/(0.25/3.00)= 0.77/0.83= 0.92 this means that price elasticity of demand is inelastic. Rachel assumption on increase in revenue was wrong as the revenue decreased by 0.25 cents but calculating the price elasticity anyone would have made the same assumption.
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