El Niño wind patterns affected the weather across the United States during the w

Question

El Niño wind patterns affected the weather across the United States during the winter of 1997-1998. Suppose the demand for home heating oil in Connecticut is given by Q = 20-2Phho + 0.5P,g-TEMP where Q is the quantity of home heating oil demanded, Phho is the price of home heating oil per unit, Png is the price of natural gas per unit, and TEMP is the absolute difference between the average winter temperature over the past 10 years and the current average winter temperature If the current price of home heating oil is $1.20, the current price of natural gas is $2.00, and the average winter temperature this year is 40 degrees compared to 28 degrees over the past 10 years, if the sellers of home heating oil want to increase total revenue, they should: a. ower prices. b raise prices c. advertise more. d. dvertise less. e. none of the above

Explanation / Answer

Correct Answer:

B.Raise prices

Working note:

Q = 20-2Phho + .5Png – Temp -------- (1)

Q = 20 – 2*1.2 + .5*2 – 12

Q = 6.6

With differentiation of eq. 1 w.r.t. Phho,

dQ/dPpho = -2

Now,

Elasticity of demand = (dQ/dPhho)*(P/Q) = (-2)*(1.2/6.6)

Elasticity of demand = -.36

Since, the elasticity is less than 1 in absolute value, then the demand is relatively inelastic and price should be increased. It will increase the total revenue.

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