Pauline has been selling 5000 widgets per year for 850 When

Pauline has been selling 5,000 widgets per year for $8.50. When she raised the price to $9.50 she sold only 4,000 widgets. What is the elasticity of demand? If her marginal cost is $4 for each widget produced, what is her optimal markup and what is her actual markup? In this case, do you believe increasing the price was a good idea?

Solution

Elasticity of demand (E_D) = Change in quantity / Change in price * Initial Price / Intital quantity

= 1000 / 1 * 8.5 / 5000

= 1000 * 8.5 / 5000

= 8500 / 5000

= 1.7

Conclusion:- Elasticity of demand = 1.7 [Demand is elastic i.e. E_D > 1 ]

Calulation of markup:-

Revenue

(-) Cost @ $ 4 per widget

(5000 * 8.50) = 42500

(5000 * 4) = 20000

(4000 * 9.5) = 38000

(4000 * 4) = 16000

Increasing the price was not a good idea, because Revenue of Pauline falls and as a result of this profit (markup) also falls by $ 500 (22500 - 22000) .