Assignment Question
Use the space here to calculate the price elasticity of demand using the midpoint formula when the price falls from $8 to $6. Show your work and record your answer in the next question. View keyboard shortcuts pView keyboard shortcutsAccessibility Checker 0 words Switch to the html editorFullscreen Flag question: Question 2 Question 25 pts The value of the coefficient is [ Select ] [“2.33”, “0.43”, “0.67”, “0.29”, “2.0”] therefore this good has a relatively price [ Select ] [“inelastic”, “elastic”, “perfectly inelastic”, “perfectly elastic”, “unit elastic”] demand. The firm should [ Select ] [“increase”, “decrease”, “not change its”] price to increase total revenue as the good likely has [ Select ] [“many”, “few”] substitutes Flag question: Question 3 Question 310 pts A firm selling a normal good has a price elasticity of demand coefficient of 3.0 and an income elasticity of demand coefficient of 2.2. Assume that economists forecast a recession within the next year with an anticipated decline in income of 12% caused by an increase in unemployment. How would you advise this firm to prepare for this recession? Explain your answer. (5 points) If the firm takes no action, by how much would the demand for its product decline? (5 points)
Assignment Question
To calculate the price elasticity of demand using the midpoint formula, you can use the following formula:
Price Elasticity of Demand = [(Q2 – Q1) / ((Q2 + Q1) / 2)] / [(P2 – P1) / ((P2 + P1) / 2)]
Where: Q1 = Initial quantity demanded Q2 = New quantity demanded P1 = Initial price P2 = New price
In this case, the initial price (P1) is $8, the new price (P2) is $6. You’ll also need to know the initial quantity demanded (Q1) and the new quantity demanded (Q2) to complete the calculation.
Assuming you have those values, you can plug them into the formula to calculate the price elasticity of demand. Let’s calculate it:
Price Elasticity of Demand = [(Q2 – Q1) / ((Q2 + Q1) / 2)] / [(P2 – P1) / ((P2 + P1) / 2)]
Price Elasticity of Demand = [(Q2 – Q1) / ((Q2 + Q1) / 2)] / [(6 – 8) / ((6 + 8) / 2)]
Now, calculate the values in the brackets:
Price Elasticity of Demand = [(Q2 – Q1) / ((Q2 + Q1) / 2)] / [-2 / (14 / 2)]
Price Elasticity of Demand = [(Q2 – Q1) / ((Q2 + Q1) / 2)] / [-2 / 7]
Now, you’ll need the values of Q2 and Q1 to proceed with the calculation. Once you have those values, you can plug them into the formula to find the price elasticity of demand.
Once you have the value for the price elasticity of demand, you can determine whether it’s elastic, inelastic, etc., based on its magnitude, and provide the appropriate advice to the firm regarding price changes and total revenue.
- Price Elasticity of Demand (PED) is 3.0: This means that the demand for the firm’s product is elastic. When PED is greater than 1, it indicates that the demand for the product is sensitive to price changes.
- Income Elasticity of Demand (YED) is 2.2: This indicates that the firm’s product is a normal good. When YED is positive, it means that as income increases, demand for the product also increases.
Given the forecasted recession with an anticipated decline in income of 12%, the firm should consider the following:
Since the firm’s product is a normal good with a YED of 2.2, a 12% decrease in income would likely lead to a decrease in the quantity demanded for the product. People tend to buy less of normal goods when their incomes decline.
Advice for the firm: To prepare for the recession, the firm should consider the following strategies:
- Diversify Product Line: Consider diversifying the product line to include lower-priced alternatives or products with broader appeal, especially targeting lower-income consumers who may be more price-sensitive during a recession.
- Price Adjustments: Given the elastic demand (PED = 3.0), the firm may consider lowering its prices during the recession. Lowering prices can help mitigate the drop in demand and potentially maintain or even increase market share.
- Cost Reduction: Look for ways to reduce production costs without compromising product quality. Cost reduction measures can help maintain profitability, even with lower prices.
- Marketing and Promotion: Invest in targeted marketing and promotional campaigns to emphasize the value and affordability of the product, particularly in comparison to competitors.
- Customer Loyalty Programs: Implement loyalty programs to retain existing customers and encourage repeat purchases.
- Monitor Demand: Continuously monitor the demand for the product during the recession to make timely adjustments to pricing and marketing strategies.
Now, to calculate how much the demand for the product might decline, you can use the income elasticity of demand (YED). The formula for the percentage change in quantity demanded due to a percentage change in income is:
Percentage Change in Quantity Demanded = YED * Percentage Change in Income
Percentage Change in Quantity Demanded = 2.2 * (-12%) = -26.4%
So, the demand for the firm’s product is expected to decline by approximately 26.4% if there is a 12% decline in income during the recession.
Frequently Asked Questions (FAQs)
FAQ 1: What is Price Elasticity of Demand (PED) and how is it calculated using the midpoint formula?
Answer: PED measures how responsive the quantity demanded of a good is to changes in its price. It is calculated using the midpoint formula, which considers percentage changes in both price and quantity to provide a more accurate measure of elasticity.
FAQ 2: How does the value of the PED coefficient determine whether a good has elastic or inelastic demand?
Answer: If the PED coefficient is greater than 1, the good is considered elastic, indicating that demand is sensitive to price changes. If the coefficient is less than 1, it’s inelastic, suggesting that demand is less responsive to price changes.
FAQ 3: What does the concept of “normal goods” and “income elasticity of demand (YED)” mean in economics?
Answer: Normal goods are products for which demand increases as consumer incomes rise. YED measures the responsiveness of demand to changes in income. A positive YED suggests a normal good, while a negative YED indicates an inferior good.
FAQ 4: How should a firm prepare for a recession if it sells normal goods with an income elasticity of demand of 2.2?
Answer: During a recession, when income is expected to decline, a firm should consider strategies such as diversifying its product line, adjusting prices, reducing costs, and focusing on marketing and customer loyalty to mitigate the impact of decreased demand.
FAQ 5: What is the relationship between price elasticity of demand (PED) and a firm’s pricing strategy for maximizing total revenue?
Answer: To maximize total revenue, a firm should consider the elasticity of demand. If demand is elastic (PED > 1), lowering prices may increase total revenue. If demand is inelastic (PED < 1), raising prices may be more profitable. In cases of unitary elasticity (PED = 1), total revenue remains constant with price changes.
