1. If you were working in a gas station and the manager wants to increase the pr
ID: 1134283 • Letter: 1
Question
1. If you were working in a gas station and the manager wants to increase the price of gasoline 5%,
(a) what would you tell him about future revenue? (Consider the theory of price elasticity and the specific value of the price elasticity for gasoline provided in the voice over)
(b) What strategies would you recommend with the price of gasoline and the prices of other products sold at the gas station?
2. A local restaurant offers an "all you can eat" ribs special. If a person pays $11.95, he can eat as many servings as he desires at no additional cost. Do you think the local restaurant will go bankrupt because people will eat much more than what they are paying for? Why?
Explanation / Answer
1) a) As far as the case of gasoline is concerned We have observed that the price elasticity of demand for gasoline is usually less than 1 in the short run. More generally the price elasticity in around 0.70. Because the demand is inelastic any price increase is expected to increase the revenue as well. This happens because the demand is inelastic and whenever its price is increased consumers reduce their consumption less than proportionately. This results in an increase in the future revenue.
b) Demand for gasoline is inelastic overall for all gas stations which indicates that if all gas stations increase the price of gasoline simultaneously then all of them can on a higher revenue. But if one gas station increases its price it will experience a reduction in its revenue because demand for gasoline by a single gas station is elastic due to the presence of other gas stations. Therefore, if prices are going to be increased they should be increased by all the gas stations otherwise not.
2) The restaurant will not get bankrupt because of two reasons. Firstly, they have limited capacity to eat and therefore they will stop when they are full. Secondly, there is a principle called diminishing marginal utility. By paying a lump sum amount add in advance, people will experience that as they continue to eat, the marginal utility derived from food will continue to fall and they will stop eating food when it turns negative.
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