Question

Taco Del Mar has completed a study of weekly demand for its tacos in Washington State's regional markets. The study produced the following demand function: Q=650-I ,000P + 0.8A + 65Pop + 500P, where Q is the number of tacos sold per store per store per week; A is the level of local advertising expenditure in dollars; Pop is the local population in thousands; and Pe is the average taco price of local competitors. For the typical Taco Del Mar outlet, P = $2.50, A= S6,000, Pop=70, and Pc=$2.25
a) Estimate the weekly revenue in dollars for the typical Taco Del Mar (given the above information).b) What is the own price elasticity for Taco Del Mar tacos under typical conditions?c) Should Taco Del Mar raise its taco prices? Discuss why or why not.

Answer 1

Answer: a. 8625 b -0.37% c. no they should not increase the price

Explanation:

a. Q= 650 -1000P + 0.8A + 65Pop +500P

   Q = 650 – 1000(2.50) + 65(70) + 500(2.25)

    Q = 8625

When the Price of tacos is $2.50, 8625 tacos will be demanded

b. Own price elasticity

Own Price elasticity measures the sensitivity of demand to a change in the price of a good or service. Price elasticity shows how much a unit change in price will affect the quantity demanded. Firms use price elasticity to test if it is possible for a firm to generate more profits by decreasing or increasing the price of a good or service they are selling.

Price elasticity calculation.

a. Q= 650 -1000P + 0.8A + 65Pop +500P

   Q = 650 – 1000(2.50) +0.8(6000) + 65(70) + 500(2.25)

    Q = 8625

Now Assume price increased from $ 2.50 to $ 3.50  

Q = 650 -1000P + 0.8A + 65Pop +500P

Q = 650 – 1000(3.50) + 0.80(6000) + 65(70) + 500(2.25)

Q = 7625. If the price increase by $ 1 quantity demanded will be 7625

P2 = 3.50, P1 = 2.50  Q2 = 7625 Q1 = 8625

Price elasticity = (Q2-Q1)/(Q2+Q1) divided by (P2-P1)/(P2+P1)

                              =(7625-8625)/(7625+8625) divided by (3.50-2.50)/(3.50+2.50)

                               = - 0.3692

  Price Elasticity    = - 0.37% (rounded off to two decimal point)

c. The Price elasticity is negative (-0.37%) meaning if Taco Del Mar increase the price by a unit ($ 1 for example) the demand for Taco Del Mar’s tacos will fall by 0.37%. Taco Del Mar should not increase the price of tacos as they are a negative Price elasticity which indicates an inverse relationship between the price of tacos and quantity demand of tacos. Taco Del Mar will however generate profits when the price of local competitors increases because competitor’s price increase will drive consumers /customers to Taco Del Mar.