A. Data for the market for graham crackers is shown below. Calculate the elastic

ID: 1195037 • Letter: A

Question

A. Data for the market for graham crackers is shown below. Calculate the elasticity of demand between the following prices.

Now, assume the price of graham crackers is $2.75. Should firms raise or lower their prices if they want to increase revenue? Explain this in terms of elasticity.

B. Assume the competitive market shown below faces a short run price of $10. Using the graph below, identify the following: Profit-maximizing output: _______________________ In the long run, the price falls to $7.50. Why does this happen? What is the new profit-maximizing output? _______________________

Quantity Demanded (per month) Price of crackers S3 $2.5 $2 $1.5 80 160 200 240 $1.00-$1.50 $1.50-S2.00 $2.00-$2.50 $2.50-$3.00

Explanation / Answer

Elasticity= dP/(P1+P2)/dQ/(Q1+Q2)

Elasticity

AVG(P1,P2)

AVG(Q1,Q2)

1-1.5

240

1.5

200

0.5

1.25

220

0.454545

1.5-2

1.5

200

160

0.5

1.75

180

0.777778

2-2.5

160

2.5

120

0.5

2.25

140

1.285714

2.5-3

2.5

120

0.5

2.75

100

2.2

When price is $2.75, its elasticity is greater than 1. So any fall in price will increase the output by greater proportion which will increase the firm revenue. So firm must reduce the price of its product.

P=MR, when maximises output where MR=MC.

So output produce at price 10 will be 110.

In short-run firm is making positive profit, so new firm will enter the market. Due to more competition, price of product will fall. In long run P=ATC=MC, where firm profit will becomes zero and entry of new firm will stop. Market will be in equilibrium in this condition.

New profit maximising output=90.