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Managerial Economics Questions: Arc Elasticity

Facts:

Company XYZ Sells Drums Sets. At a price of $600 per set, they sold 500 Sets per month. The new manager decided that the company needed more revenue so she increased the price to $700 per set. However the company is now selling only 200 drum sets per month at the new price.

Questions:

1.What is the arc price elasticity for this product? Show work with results.

2.What do you recommend for the price of this product; stay at $700 or change higher or lower?

3.What additional information would be useful in the pricing decision?

4. What would be your recommendation for setting up a model to forecast future demand for this product?

Attachments

Solution Preview

1.
P1 = $600
Q1 = 500
P2 = $700
Q2 = 200

The formula for arc elasticity uses the midpoint between the two known points on the Demand curve.

Ed = ((Q2-Q1)/(Q1+Q2)/2)/((P2-P1)/(P1+P2)/2)

Substituting the known ...

Solution Summary

This solution works out a concrete example of how to calculate the arc elasticity of demand for a product, and then to use that information to make pricing decisions.

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