EET 2. a) below average revenue. You decide to conduct a pricing Suose you own a

Question

EET 2. a) below average revenue. You decide to conduct a pricing Suose you own a Starbucks offe hop in your town. Both of your locations are generating experiment. The results of the pricing experiment are as follows: an increase in the price of latte from to $5.50 resulted in a drop of quantity demanded from 450 to 350 cups of latte per day Toen thmation, how should you alter your latte pricing policy to increase your total revenue? your revenue. Briefly explain your answer (8 pts.). To answer this formula and based change in price question you need to compute the price elasticity of demand using the midpoint on your computation you have to decide whether an increase, a decreass, r b) (Not related to part a) Suppose that the state of Massachusetts has recently increased the tax on cookies. If the price elasticity of demand for cookies is -0.9 and the price elasticity of supply is 2.3 who will bear more of the burden of the tax? Why? Explain very briefly. (3 pts.) c) (Not related to parts a and b) Determine whether the demand for a chocolate cake is likely to be more OR less elastic than the demand for cakes in general. Briefly explain your choice.

Explanation / Answer

a) According to the mid-point formula, the price elasticity of demand for a product is given by:

Ed = (Q2 – Q1) / [(Q2 + Q1)/2] / (P2 – P1) / [(P2 + P1)/2].

Use the values Q1 = 450 and Q2 = 350, P1 = 4.5 and P2 = 5.5, find elasticity of demand which turns out to be -1.25

Since elasticity is greater than 1, demand is inelastic and so raising prices will reduce revenue. Hence prices should be reduced to raise revenue

b) Share of tax borne by seller = elasticity of demand / (elasticity of demand + elasticity of supply) = 0.9/(0.9 + 2.3) = 28.5%

Share borne by buyer = elasticity of supply/ (elasticity of demand + elasticity of supply) = 2.3/(0.9 + 2.3) = 71.5%

It is clear that buyer bears a greater burden of tax

c) Demand for cakes in general is less elastic because it is more broadly definee and so demand for chocolate cake is more elastic which is narrowely defined.

Q1 Q2 P1 P2 Q2-Q1 (Q2+Q1)/2 %Q P2-P1 (P1+P2)/2 %P Ed Investigating Latte 450.00 350.00 4.50 5.50 -100.00 400.00 -25.00 1.00 5.00 20.00 -1.25

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