Question

How would you answer this question?

Answer 1

Answer: Choice B

If you lower your rates by 6% you will increase the number of occupancies by 12%

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Explanation:

Price Elasticity of Demand is found by dividing the percent change of demand over the percent change in price

$\text{Price Elasticity of Demand} = \frac{\% \text{ change in demand}}{\% \text{ change in price}}$

If the price drops 6% leads to a 12% increase in demand, then we get this elasticity

$\text{Price Elasticity of Demand} = \frac{\% \text{ change in demand}}{\% \text{ change in price}}\\\\\text{Price Elasticity of Demand} = \frac{12\% \text{ increase in demand}}{6\% \text{ drop in price}}\\\\\text{Price Elasticity of Demand} = \frac{12\%}{-6\%}\\\\\text{Price Elasticity of Demand} = \frac{0.12}{-0.06}\\\\\text{Price Elasticity of Demand} = -2$

The absolute value of that result is 2. We work backwards going from 2 to see the relationship between the 12% and 6%.

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Side notes:

• Choice A is incorrect as a price elasticity of demand larger than 2 means we have elastic (rather than inelastic) demand.
• Choice C is incorrect because while raising rates does bring in more money in certain situations, there's a limit to how much the price goes up before people stop showing up. The prices can't go up forever. Also, the fact we have an elastic product means people are either forgoing this hotel or finding a substitute.
• Choice D is incorrect. Products with high demand elasticity usually have substitutes. Any slight change in the price leads people to seek cheaper options. Unless we're dealing with a small town there are usually multiple hotels to choose from.