ECON 1580 Unit 2: Written Assignment

Course: Introduction to Economics

Instructor: Ms. Karen Roush

Date submitted: Friday, November 22, 2024

Deadline for submission: Wednesday, November 27, 2024, 11:55 PM

Demand and Supply

Elasticity: A Measure of Response

Introduction
As the manager of a restaurant, it is essential to grasp the intricate relationship between price
and quantity demanded, as this directly impacts the establishment’s profitability and customer
satisfaction. In our analysis, we have established a baseline of our average daily meals served
alongside the average price charged per meal.

To delve deeper into consumer behavior, we undertook a comprehensive survey of our

patrons. The results indicated a clear trend: a reduction in meal prices would likely lead to a
significant increase in the quantity of meals demanded. This finding opens the door to an in-
depth exploration of how such a price adjustment could influence our overall revenue and the
restaurant’s operational success.

Specifically, we can model different pricing strategies to forecast potential sales volumes
under various scenarios. It's critical to consider how this price elasticity might not only
contribute to a temporary surge in customer traffic but also affect the restaurant's brand
perception and long-term loyalty among diners. Therefore, analyzing the implications of
price adjustments will be pivotal in driving both immediate and sustainable business growth.

1. To compute the price elasticity of demand (PED) between the two points, you can use
the following formula:

[ \text{PED} = \frac{%\ \text{change in quantity demanded}{%\ \text{change in

price}]

To begin with, determine the percentage change in the quantity demanded:

[ %\ \text{percentage change in quantity demanded} = \frac{\text{New quantity} - \

text{Original quantity}{\text{Original quantity} \times 100} ]

[ %\ \text{change in quantity demanded} = \frac{450 - 400}{400} \times 100 =

12.5% ]

Next, calculate the percentage change in price:

[ %\ \text{change in price} = \frac{\text{New price} - \text{Original price}{\

text{Original price} \times 100 ]

The formula for calculating the price change is given by: [ %\ \text{change in price} =
\frac{18 - 20}{20} \times 100 = -10% ].
 Please apply these figures to determine the price elasticity of demand:

[ \text{PED} = \frac{12.5%}{-10%} = -1.25 ]

The price elasticity of demand calculated between these two points is -1.25.

2. Total Revenues and Price Elasticity of Demand

When the price elasticity of demand (PED) exceeds 1, we categorize demand as
elastic. This indicates that consumers respond significantly to price changes.
Specifically, if the price of a good or service decreases, the quantity demanded
increases by a more substantial percentage than the price decrease itself. This
relationship results in an overall increase in total revenue for the seller because more
units are sold at the lower price (Rittenberg & Tregarthen, 2009).

On the other hand, if the price increases, the quantity demanded declines significantly,
resulting in a more than proportionate decrease in consumer purchases. In this
scenario, total revenue decreases because the fewer units sold cannot compensate for
the higher price.

In our specific case, the calculated price elasticity of demand is -1.25. This negative
value indicates elastic demand, confirming that consumer behavior aligns with the
previously mentioned principles. A decrease in price would yield a significant
increase in the quantity demanded, driven by price-sensitive consumers eager to take
advantage of the lower cost. As a result, the total revenue would rise due to the surge
in sales volume.

Conversely, should the price be increased, we would observe a substantial decline in

the quantity demanded. Consumers, reacting to the higher price, would opt to
purchase less, leading to a decrease in total revenue. This interplay between price
changes and consumer response underscores the dynamics of elastic demand,
highlighting the importance of pricing strategy in maximizing revenue.

3. To compute the price elasticity of demand (PED) between the two points, we can use
the formula (Rittenberg & Tregarthen, 2009):
PED = (Q2 - Q1) / (Q2 + Q1) / 2) / (P2 - P1) / (P2 + P1) / 2)
 Where:

 Q1 = initial quantity demanded (450 meals)

 Q2 = new quantity demanded (500 meals)
 P1 = initial price ($18)
 P2 = new price ($16)
First, calculate the change in quantity demanded and the change in price: (Q2 - Q1) =
500 - 450 = 50 (P2 - P1) = 16 - 18 = -2
Then, calculate the average quantity and average price: ((Q2 + Q1) / 2) = (500 +
450) / 2 = 475 ((P2 + P1) / 2) = (16 + 18) / 2 = 17
Now, substitute these values into the PED formula: PED = ((50 / 475) / (-2 / 17)) PED
= (0.1053) / (-0.1176) PED ≈ -0.895
The price elasticity of demand calculated between these two-points is around -0.895.
This suggests that the demand is inelastic, since the absolute value of the price
elasticity of demand is below 1.

4. Price Elasticity of Demand Calculation

To determine the price elasticity of demand (PED) at the two price levels, we can
apply this formula:
PED = (Q2 - Q1) / (Q2 + Q1) / 2) / ((P2 - P1) / (P2 + P1) / 2)
Where:

 Q1 = Initial quantity demanded (450 meals)

 Q2 = New quantity demanded (500 meals)
 P1 = Initial price ($18)
 P2 = New price ($16)
Substitute the values into the formula:
The price elasticity of demand (PED) is calculated as follows:
PED = ((500 - 450) / ((500 + 450) / 2)) / ((16 - 18) / ((16 + 18) / 2)).
This simplifies to: (50 / 475) / (-2 / 17).
= (50 / 475) / (-2 / 17)
= (0.1053) / (-0.1176)
= -0.895
The demand's price elasticity between the two points is roughly -0.895.
Total Revenue Expectation
 Based on the price elasticity of demand (PED) being around -0.895, we can anticipate
the following:
- When PED is less than -1, demand is considered elastic, meaning that lowering the
price will result in an increase in total revenue.
- When PED falls between -1 and 0, demand is classified as inelastic, indicating that a
price decrease will cause total revenue to decline.
- When PED equals -1, demand is unit elastic, which means that total revenue stays
the same.

In this case, with a PED of approximately -0.895, the demand is inelastic. Therefore, a
further reduction in price from $18 to $16 would lead to a decrease in total revenue.
This is because the percentage increase in quantity demanded is less than the
percentage decrease in price, resulting in a net decrease in total revenue (Rittenberg &
Tregarthen, 2009).

5. To calculate the overall revenue at the three meal prices, we can apply the
formula: Total Revenue = Quantity Demanded * Price per Meal.
(b) At the original price of $20: Total Revenue = 400 * $20 = $8,000
(d) At the reduced price of $18: Total Revenue = 450 * $18 = $8,100
By analyzing these figures, it can be confirmed that the overall revenue at the lowered
price of $18 exceeds that at the initial price of $20. This supports the idea that
lowering the price can result in a rise in total revenue, provided that the growth in
quantity demanded offsets the reduced price (Rittenberg & Tregarthen, 2009).

In concluding
The recent decision to lower the price of an average meal from $20 to $18 could significantly
influence the daily quantity of meals demanded by customers at the restaurant. This strategic
move is likely to attract more patrons who may have previously considered the meal pricing
to be too high. However, it's crucial for the restaurant manager to conduct a thorough analysis
of the potential impacts this price reduction might have on overall revenue and profitability.

A careful examination of the principles of demand—particularly the price elasticity—will be

essential in understanding how sensitive customers are to price changes. When demand is
elastic, lowering the price can result in a greater proportional rise in the quantity sold, which
could increase total revenue. Conversely, if the demand is inelastic, the reduction in price
might not yield sufficient increases in sales to offset the lowered revenue per meal.

In addition to these financial considerations, the manager should also consider factors such as
customer perception, the quality of the dining experience, and competitors' pricing strategies.
By aligning the price reduction with marketing efforts and operational costs, the restaurant
can optimize its business performance while simultaneously enhancing customer satisfaction
and loyalty. Informed decision-making rooted in these evaluations will be key to ensuring
that the restaurant thrives in a competitive market.

References

Rittenberg, L. & Tregarthen, T. (2009). Demand and Supply. Chapter 3. Principles of

Economics. Flat World Knowledge.
https://my.uopeople.edu/pluginfile.php/1928588/mod_page/content/19/
PrinciplesOfEconomicsChapter03.pdf

Rittenberg, L. & Tregarthen, T. (2009). The Price Elasticity of Demand. Chapter 5. Principles
of Economics. Flat World Knowledge.
https://my.uopeople.edu/pluginfile.php/1928588/mod_page/content/19/Principles%20Of
%20Economics%20Chapter%2005.pdf