Question

you are the manager of a hamburger joint with a marginal cost of $6.00 per hamburger. The hamburger joint is a local monopoly near campus. During the day, only students eat at the joint while in the evening only the faculty members eat there. If students have an elasticity of demand for hamburger of -4 and the faculty has an elasticity of demand of -3, what should your pricing strategy be to maximize profits?

Answer 1

Answer:

A low-price strategy

Explanation:

Price elasticity of demand is the responsiveness of quantity demand to a change in price. It is calculated by dividing the % change in quantity demanded by the % change in price.

1. Perfectly elastic demand: Even no changes in price causes a change in quantity demanded (horizontal demand curve)
2. Elastic demand: Change in price causes a relatively higher change in quantity demanded (Sloped demand curve, PES > 1)
3. Unitary elastic demand: Change in price causes the same change in quantity demanded (PES = 1)
4. Inelastic demand: Change in price causes a relatively lower change in quantity demanded (Steep slope in demand curve, PES < 1)
5. Perfectly inelastic demand: Even with changes in the price, there is no change in the quantity demanded (vertical demand curve).

In this case, demand for hamburgers by both students and faculty is elastic since it is 4 and 3 respectively and hence higher than 1. Thus, any change in price will cause a higher change in quantity demanded.

Note: The negative figures DOES NOT mean less than 1. The negative figure is because price and quantity demanded have an inverse relationship (when one rices, the other falls). Hence, even -4, -3, -6 are all elastic. However, -0.2, -0.9 and such are considered inelastic.

When demand is elastic, a fall in price will help to maximize total revenue and profits, because when price falls by a certain amount, demand will increase by a much larger amount. Thus, in order to maximize profits, a low-price strategy should be used. In this low price strategy, students should be charged lower than faculty members, since students have a more elastic demand compared to faculty members. For example, students can be charged $5.6 and faculty members $5.8