1. Analysis of Pricing: You manage Mt. Claire Café which sells meals at a price
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Question
1. Analysis of Pricing: You manage Mt. Claire Café which sells meals at a price of $8.50 each. The meal includes a hot dish and a beverage of your choice. The average number of meals sold per month is 21,000. The owners of Mt. Claire Café would like to increase its sales and profits. They know that if price is lowered, they will sell more meals. So they run an experiment. Price is lowered to $7.50 per meal in March and the number of meals sold increases to 23,000. a. What is the Price Elasticity of Demand? b. Is elasticity elastic, inelastic or neither? c. What does this mean and why does it matter? d. Will Revenues increase or decrease as a result of the price cut? By How much? e. Beatrice has calculated the fixed costs for the Café are $18,000 per month and each meal costs $4.50. Will profits go up or down as a result of the price cut? By How much
Explanation / Answer
(a) Original quantity = 21,000 meals
Original price = $8.50 per meal
New quantity = 23,000 meals
New price = $7.50 per meal
Change in quantity = New quantity - Original quantity = 23,000 meals - 21,000 meals = 2,000 meals
Change in price = Original price - New price = $8.50 - $7.50 = $1.00
Price elasticity of demand = (Change in quantity demanded/Change in price)*(Original price/Original quantity)
= (2,000/1)*(8.50/21,000)
= 0.81
The price elasticity of demand is 0.81.
(b) The price elasticity of demand for meals is 0.81. When elasticity is less than 1, demand is said to be inelastic.
So, in given case, elasticity is inelastic.
(c) The demand for meals is inelastic.This means that percentage change in quantity demanded of meal is greater than the percentage change in price of meal.
This matters because when demand for a product is inelastic, an increase in price leads to higher total revenue while a decrease in price leads to lower total revenue while opposite happens when demand for a product is elastic.
So, elasticity dictates whether price should be raised or decreased to enhance sales and profit.
(d) Total revenue before price cut -
Price = $8.50 per meal
Quantity = 21,000 meals
Total Revenue = $8.50 * 21,000 = $178,500
The total revenue before price cut is $178,500.
Total revenue after price cut -
Price = $7.50 per meal
Quantity = 23,000 meals
Total Revenue = $7.50 * 23,000 = $172,500
The total revenue after price cut is $172,500.
Thus, total revenue has decreased as a result of price cut.
Total revenue has decreased by ($178,500 - $172,500) $6,000.
(e) Total revenue before price cut -
Price = $8.50 per meal
Quantity = 21,000 meals
Total Revenue = $8.50 * 21,000 = $178,500
The total revenue before price cut is $178,500.
Total cost before price cut -
Fixed cost = $18,000
Variable cost = $4.50 * 21,000 = $94,500
Total cost = $18,000 + $94,500 = $112,500
Profit = Total revenue - Total cost = $178,500 - $112,500 = $66,000
The profit before price cut is $66,000.
Total revenue after price cut -
Price = $7.50 per meal
Quantity = 23,000 meals
Total Revenue = $7.50 * 23,000 = $172,500
The total revenue after price cut is $172,500.
Total cost after price cut -
Fixed cost = $18,000
Variable cost = $4.50 * 23,000 = $103,500
Total cost = $18,000 + $103,500 = $121,500
Profit = Total revenue - Total cost = $172,500 - $121,500 = $51,000
The profit after price cut is $51,000.
Thus, the profit has decreased as a result of price cut.
Profit has decreased by ($66,000 - $51,000) $15,000.
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