Management of Mr. Taco has completed a study of weekly demand for its “old fashi

Question

Management of Mr. Taco has completed a study of weekly demand for its “old fashioned tacos” in 23 regional markets. The study revealed the following demand equation:

Q = 400- 1200P + 0.8A + 800Pc + 55pop

where Q is the number of tacos sold per store per week and P is the price of its own “old fashioned tacos” . A is the level of local advertising expenditure, pop is the local population and Pc is the average taco price of local competitors. For the typical Mr. Taco outlet, P =$1.50, A = $1000, pop = 40 and Pc = $1.

Should Mr. Taco raise its taco price? Explain.

Explanation / Answer

Demand equation: Q = 400- 1200P + 0.8A + 800Pc + 55pop

Using the given values, calculate value of Q as: Q = 400- 1200(1.5) + 0.8(1000) + 800(1) + 55(40) = 2400

Calculate price elasticity of demand as: (dQ/dP)(P/Q) = (-1200)(1.5/2400) = -0.75

Since the price elasticity of demand is less than 1, it is inelastic in nature. This means a proportionate change in P will lead to a less than proportionate change in Q

As per the TR test of elasticity, increasing prices in case of inelastic demand leads to an increase in total revenues.

Hence, Mr. Taco should increase its taco price.

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