Suppose you are the manager of a restaurant that serves an a

Suppose you are the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of $20. On the basis of a survey, you have determined that reducing the price of an average meal to $18 would increase the quantity demanded to 450 per day.

a. Compute the price elasticity of demand between these two points.

b. Would you expect total revenues to rise or fall? Explain.

c. Suppose you have reduced the average price of a meal to $18 and are considering a further reduction to $16. Another survey shows that the quantity demanded of meals will increase from 450 to 500 per day. Compute the price elasticity of demand between these two points.

d. Would you expect total revenue to rise or fall as a result of this second price reduction? Explain.

Solution

Price and demand are inversely related to each other.

Elasticity = % change in quantity / % change in price

(a) Elasticity = (450-400)/400 / (18-20)/20

= - 1.25

Since elasticity is greater than 1, the demand is elastic.

(b) If demand is elastic, then decreasing price would increase the demand by greater amount and hence the total revenue would increase.

(c) elasticity = (500-450)/450 / (16-18)/18

elasticity = -1

The demand is unit leastic at this point.

(d) The percentage change in price would be equal to change in quantity. There will be no change in total revenue.