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# The Olde Yogurt Factory has reduced the price of its popular Mmmm Sundae from \$2.25 to \$1.75.

As a result, the firms daily sales of these sundaes have increased from 1,500/day to 1,800/day. Compute the arc price elasticity of demand over this price and consumption quantity range.

Solution: Arc elasticity is the elasticity of one variable with respect to another between two given points. The P arc elasticity of Q is calculated as

or

## Ep = ((1800-1500) / ((1800+1500) / 2)) / ((1,75-2,25) / ((1,75+2,25) / 2))= - 0,727

So the price elasticity of demand is -72,7 %. It is common to use the absolute value of price elasticity, since for a normal (decreasing) demand curve they are always negative. Thus the demand of these sundaes has 72,7 % elasticity, and is therefore inelastic.

Consumption quantity varies from 1500/day to 1800/day and its range is 300/day (1800-1500).

1. The Stopdecay Company sells an electric toothbrush for \$25. Its sales have averaged 8,000 units per month over the last year. Recently, its closest competitor, Decayfighter, reduced the price of its electric toothbrush from \$35 to \$30. As a result, Stopdecays sales declined by 1,500 units per month.
a. What is the arc cross elasticity of demand between Stopdecays toothbrush and Decayfighters toothbrush? What does this indicate about the relationship between the two products? b. If Stopdecay knows that the arc price elasticity of demand for its toothbrush is 1.5, what price would Stopdecay have to charge to sell the same number of units as it did

before the Decayfighter price cut? Assume that Decayfighter holds the price of its toothbrush constant at \$30. c. What is Stopdecays average monthly total revenue from the sale of electric toothbrushes before and after the price change determined in part (b)? d. Is the result in part necessarily desirable? What other factors would have to be taken into consideration?
2. .a Please note that the arc crosses elasticity of demand between Stopdecay's oven and the competitive spring city is calculated by (Change in quantity demanded of Stopdecay/average quantity demanded of Stopdecay) divided by (Change in price of Decay fighter/ average price of Decay fighter). This translated into numbers means that (1500/7250)/(5/32.5) = +1.34. (Explanation: Quantities are 8000 and 6500, if we add these and divide it by 2 we get 7250, similarly we get the price average of 32.5). b. Stopdecay can find its own price elasticity (Change in quantity demanded of Stopdecay/average quantity demanded of Stopdecay) divided by (Change in price of Stopdecay/ average price of Stopdecay). In terms of figures we get (1500/7250)/(P - 25)/{P-25/(25 + P)/2} = -1.5. (Explanation: the new price is not known to us, however, the elasticity is given to us and the current price is known to us so we have a simple equation with one unknown.) Please try and solve the equation. You will get \$21.77 c.Before the price change the quantity was 8000 and the price was 25 so the revenue was \$200,000 After the price change the quantity will remain 8000 but the price will be 21.77 giving you total revenue of \$174,160. d. The result in par c may not be desirable because it is possible that the price reduction may lead to sales at a rate below the cost price. This may lead to losses. Thus to continue production the revenue must not only be above the cost of production but should also provide a reasonable return on capital..

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