The Jones Corporation\'s executive vice president circulates a memo to the firm\

Question

The Jones Corporation's executive vice president circulates a memo to the firm's top management in which he argues for a reductin in the price of the firm's product. He says such a price cut will increase the firm's sales and profits.

a. The firm's marketing manager responds with amemo pointing out that the price elasticity of demand for the firm's product is about -0.5. Why is this fact relevant?

b. The firm's president concurs with the opinion o fthe executive vice president. Is she correct?

c.What is the definition of price elasticity of demand? If it is -0.5, what does this really mean, in terms price and quantity sold?

d.What happens if the company reduces its price by 1%? Will the quantity sold increase or decrease? By how much?


Please help and please show your steps.

Explanation / Answer

a) e = -0.5 Say the VP wanted a 1% price reduction (the number is arbitrary and for demonstrative purposes). Demand would only increase by (0.01*0.5), 0.5%. Assume x = quantity demanded Assume y = price of good Total Sales = xy A 1% price reduction would lead to: 1.005x * 0.99y = 0.99495xy 1 > 0.99495 Therefore, total sales has decreased. Not to mention profit margin would decrease, so even if sales would increase (if |e| > 1), profits would not necessarily increase. b) He is wrong for the same reasons listed for part a. c) The price elasticity of demand is the percentage change in demand given a 1% change in price. This number is almost always negative due to the law of demand, stating that demand would increase when the price of a good increases. So here, a -0.5 indicates that the demand change would be half of the price change, in percentages. It's important to note that elasticity is not always uniform, it will decrease as you continue as the price of the good decrease, due to its percentage-nature. d) Part d was answered in part a. A 0.5% increase in demand occurs.

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