Assignment in Managerial Economics

Topic: Simple Pricing

Name: _______________________________________

Instruction: Answer the following problems. Show solutions. To be submitted on-line on Wednesday,
March 11, 2020.

1. If the price of a product decreases from 15 pesos to 12 pesos, leading to an increase in

quantity demanded from 100 to 125 units, then what is the price elasticity of demand? (2
points)

2. If the price of a product increases from 150 pesos to 200 pesos, leading to an decrease in
quantity demanded from 50 to 40 units, then what is the price elasticity of demand? (2
points)

3. On a promotion week for Coke, the price of Coke softdrinks drop by 25% and quantity
increases by 150%. What is the arc price elasticity of demand? (2 points)

4. If a person experiences a 10% increase in income, the quantity demanded for a good
increased by 10%, then what is the income elasticity of demand? What is the type of the
goods? (3 points)

5. Product A has a 20% positive change in quantity demanded when product B has a positive
10% change or increase in price. What is the cross-price elasticity of demand? What is the
type of product? (3 points)

6. e= –2, P=P20, MC= P16, should you raise price? Why? (3 points)

7. If the current price of a product is 400 pesos, current quantity produced is 2000, and
variable cost per unit is 5 pesos. a.) Compute the stay-even quantity. b.) is the actual
quantity lost will be greater or less than the stay-even quantity, and c.) will a given price
increase of 10% be profitable? (5 points)
8.
 Income elasticity of demand:
Cross-price elasticity of demand:
Product A (butter) has a 10% positive change in quantity demanded when product B
(margarine) has a positive 5% change or increase in price.
If we enter those numbers in to our formula, we see that 10% / 5% is equal to 2.

Stay-even Analysis
9. The marginal analysis of simple pricing, i.e., price at the point where MR=MC, is sometimes
implemented by using a version of break-even analysis.  Instead of asking which price
maximizes profit, you instead ask "will a given price increase, e.g., 5%, be profitable?
10.

How to Calculate the Arc Price Elasticity of Demand

If the price of a product decreases from $10 to $8, leading to an increase in quantity
demanded from 40 to 60 units, then the price elasticity of demand can be calculated as:

% change in quantity demanded = (Qd2 – Qd1) / Qd1 = (60 – 40) / 40 = 0.5

% change in price = (P2 – P1) / P1 = (8 – 10) / 10 = -0.2

Thus, PEd = 0.5 / -0.2 = 2.5

Since we’re concerned with the absolute values in price elasticity, the negative sign is
ignored. You can conclude that the price elasticity of this good, when the price decreases
from $10 to $8, is 2.5.

Arc Price Elasticity of Demand

Discussion: price changes from $10 to $8; quantity changes from 1 to 2.

Example: On a promotion week for Coke, the price of Coke softdrinks drop by 25% and
quantity increases by 300%.

should Nike raise or lower price?

Discussion: e= –2, p=$10, mc= $8, should you raise price?
Discussion: mark-up of 3-liter Coke is 2.7%. Should you raise price?
Discussion: Sales people MR>0 vs. marketing MR>MC.

Discussion: Do all demand curves slope downward?

Discussion: Give an example of the second law of demand.
Discussion: Give an example of the third law of demand

Income elasticity of demand:

For example, if a person experiences a 20% increase in income, the quantity demanded for
a good increased by 20%, then the income elasticity of demand would be 20%/20% = 1. This
would make it a normal good.
Cross-price elasticity of demand:
Product A (butter) has a 10% positive change in quantity demanded when product B
(margarine) has a positive 5% change or increase in price.
If we enter those numbers in to our formula, we see that 10% / 5% is equal to 2.

Stay-even Analysis
The marginal analysis of simple pricing, i.e., price at the point where MR=MC, is sometimes
implemented by using a version of break-even analysis.  Instead of asking which price
maximizes profit, you instead ask "will a given price increase, e.g., 5%, be profitable?"  To
answer the question, we

1. Compute the stay-even quantity, the quantity you can afford to lose and still break even

2. Predict (or guess) whether the actual quantity lost will be greater or less than the stay-
even quantity.

3.  If the actual quantity lost is less than the stay-even quantity, then the price increase will
be profitable.  

Here is the derivation of the stay-even quantity:

The benefit of a price increase is the extra revenue you earn at the new (and lower)
quantity, Benefit=dP*(Q+dQ)

The cost of a price increase is the margin on the lost sales, Cost=dQ(P-MC)

where dP=P1-P0, dQ=Q1-Q0, P0=initial price, P1=final price, Q0=initial quantity, and
Q1=final quantity.

You compute the Quantity at which you are indifferent between raising price or not, and
you get the formula:

(dQ/Q)=(dP/P)/[(dP/P)+m]

where m=(P-MC)/P, dQ/Q=% change in Q, and dP/P=% change in P.

The stay even quantity for a 5% price increase for a firm with a 40% contribution margin is
11.1%=(5%)/[(5%)+(40%)].  If you expect to lose less than 11%, then a 5% price increase will
be profitable.

Discussion: Suppose that the elasticity of demand for running shoes is –0.4 and the
market share of a Saucony brand running shoe is 20%. What is the price elasticity of
demand for Saucony running shoes?