Question

The Electronics Warehouse, Inc., is a leading retailer of home theater systems. Demand for home theater system s is sensitive to changes in national income. Electronics retailing is highly competitive, so retail demand for home theater systems is also very price-sensitive. During the past year, the Electronics Warehouse sold 550,000 home theater systems at an average retail price of $4,000 per unit. This year, GDP per household is expected to fall from $58,800 to $53,200 as the nation enters a steep recession. Without any price change, the Electronics Warehouse expects current-year sales to fall to 450,000 units.

1. Calculate the implied arc income elasticity of demand.
2. Given the projected fall in income, the sales manager believes that current volume of 550,000 units could only be maintained with a price cut of $500 per unit. On this basis, calculate the implied arc price elasticity of demand.
3. Holding all else equal, would further increase in price result in higher or lower total revenue?

Answer 1

C. The price elasticity is more than one. So the good is a elasic good. As price decreases, the increase in quantity demanded will be proportionately higher. The increase in quantity offsets the fall in price and total revenue will increase.

A & B in image.