Scenario 1: Globe Travel Agency sells Spring Break trips to University of Housto

Question

Scenario 1: Globe Travel Agency sells Spring Break trips to University of Houston undergraduate
students. The fixed cost of Globe is $100,000 and its variable cost is $400 for every student who takes
the trip Globe offers. The price elasticity of demand is -2.5 at all levels of price. At present, the price of
the trip is $600/student and, at this price, demand is 1200 units. Assume that the number of trips sold
always equals demand.
Please refer to Scenario 1. Which of the following statements is correct?

A price reduction from $600/unit will increase revenue

A price reduction from $600/unit will reduce revenue.

A price reduction from $600/unit will leave revenue unchanged.

The information given is not sufficient to reach a conclusion about how a price reduction
from $600/unit will affect revenue

A price reduction from $600/unit will increase revenue

A price reduction from $600/unit will reduce revenue.

A price reduction from $600/unit will leave revenue unchanged.

The information given is not sufficient to reach a conclusion about how a price reduction
from $600/unit will affect revenue

Explanation / Answer

Note that the price elasticity of demand is -2.5 at all levels of price. This implies that demand is elastic as |ed| > 1 and when demand is elastic, an increase in the price reduces revenue and a decrease in price increases revenue. Hence the correct choice is a price reduction from $600/unit will increase revenue

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