A specific McDonald’s franchise owner is looking at elasticities of Big Macs. E(

Question

A specific McDonald’s franchise owner is looking at elasticities of Big Macs. E(p)= 2 (Price), E(i)=1 (Income), E(mt)=1.5 (m=Big Mac, t= Taco). The franchise owner would like to increase the price of Big Macs by 6%. The owner read an economic report saying incomes will grow by 4% next year and due to a strong marketing campaign by Taco Bell, the price of Tacos will fall by 2%.

If the franchise owner currently sells 1,200 Big Macs a day, how many Big Macs a day can the owner expect to sell?

If the owner wants to keep units sold the same at 1,200 per day, by what percentage must the owner change the price of Big Macs?

Explanation / Answer

If the income increases by 4% then given the income elasticity is 1, quantity demanded will also increase by 4%.

This means Big Mac demand will increase to 1248 due to change in income.

If taco bell and Big Macs are substitutes, then fall in the price of taco bell will lead to decrease in demand of Big Mac. If price of taco bell falls by 2% and cross price elasticity is given at 1.5, then decrease in quantity demanded of big mac will be 3%.

This means demand of big mac will decrease by 36(3% of 1200).

Now demand is higher after these two changes to 1212 i.e (12/1200)*100 = 1%

If price elasticity is 2 and owner wants to decrease the demand by 1% to keep it at 1200, then price must increase by half a percent i.e.0.5%.

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