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Managerial Economics- Elasticity Concepts

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You have taken a job as pricing manager for a very fine men's clothing line that sells high-end, tailored shirts, suits, etc. The firm is interested in increasing its revenues. Because it is a "high-end" clothier, your boss does not what to have a "sale" on shirts or sweaters; he would actually rather increase the prices on either the firm's tailored shirts or the firm's hand-knit sweaters.

You know that depending on the elasticity of demand, it is possible to increase the prices for shirts or sweaters, sell fewer units but actually increase your revenues.

The last time you increased the prices on your shirts and sweaters, the shirts went from $300 each to $320 each and the sweaters went from $400 each to $430 each.

The corresponding change in demand was: Shirts dropped from an average sales of 260 a month to 242, while sweaters dropped from an average sales of 200 a month to 188.

Calculate the price elasticity of demand for shirts and sweaters.

Which one, shirts or sweaters, has a demand elasticity that will allow you to increase the price, sell fewer units BUT still increase your revenues?

Take what was chosen and increase the price 10% from the current price (the current price is $320 for shirts and $430 for sweaters) and show the new quantity demanded at that price as we did in class. Also, show that the new total revenue will be greater than then old total revenue.

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Please refer attached file for missing formulas.

Solution
First we calculate arc price elasticity of demand for shirts.
Average P=(300+320)/2=310
Average Q=(260+242)/2=251

Ep(shirts) = percentage change of P/percentage change of Q = Average P/Average Q = 242-260/320-300 * 310/251 = -18/20 * 310/251 = - 1.11

Now we calculate the arc price elasticity of demand for sweaters
Average P=(400+430)/2=415
Average Q=(200+188)/2=194

Ep(sweaters) = percentage change of P/percentage change of Q = 188 - 200/430 - 400 * ...

Solution Summary

Solution depicts the steps to estimate the price elasticity of demand for shirts and sweaters in the given case. It also analyzes the effect of price changes on the total revenue.

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See Also This Related BrainMass Solution

Concepts in Managerial Economics

1. In a competitive market, the market-determined price is $60. For a typical firm producing 100 units of output, short-run marginal cost is constant at $65, average total cost is $95, and average fixed cost is $30. Is this firm making the profit-maximizing decision? If not, what should it do?
a) No, it is not making the profit maximizing decision. In the short run, it should reduce its rate of production until its marginal cost is equal to $60.
b) Yes, it is making the profit-maximizing decision.
c) No, it is not making the profit maximizing decision. In the short run, it should increase its rate of production until its marginal cost is equal to $60.
d) No, the firm is not making the profit maximizing decision. It should shut down in the short run to minimize losses.

2. When price is greater than average variable cost but less than average total cost at the profit-maximizing level of output, a firm should
a) continue to produce the level of output at which marginal revenue equals marginal cost.
b) increase output to minimize its losses.
c) reduce output to the level at which price equals average variable cost to minimize its losses.
d) shut down to minimize its losses.

3. In a competitive market, the market-determined price is $25. For a typical firm producing 10,000 units of output, the firm's average cost reaches its minimum value of $25. Is this firm making the profit-maximizing decision? If not, what should the firm do?
a) No, it is not making the profit-maximizing decision. In the short run, it should reduce its rate of production because its marginal cost is not equal to $25.
b) Yes, it is making the profit-maximizing decision.
c) No, it is not making the profit-maximizing decision. In the short run, it should increase its rate of production because its marginal cost is not equal to $25.
d) No, it is not making the profit-maximizing decision. In the short run, it should reduce its rate of production until its average variable cost is equal to $12.

4. In the purely competitive case, marginal revenue (MR) is equal to
a) cost.
b) profit.
c) price.
d) total revenue.

5. If price exceeds average costs for a typical firm in a perfectly competitive industry, ____ firms will enter the industry, supply will ____, and price will be driven ____.
a) no new; remain the same; up
b) more; decrease; down
c) more; decrease; up
d) more; increase; down

6. Which of the following statements is not a characteristic of a perfectly competitive market?
a) Large number of firms in the industry
b) Outputs of the firms are perfect substitutes for one another
c) Limited information is available to all market participants
d) Ease of entry into the market

7. The perfectly competitive firm
a) faces a downward-sloping demand function.
b) can influence market price only in a downward direction.
c) cannot earn any economic profits in the short run because it faces a horizontal demand curve.
d) makes its profit-maximizing decision only on the basis of output.

8. The following are the inverse demand curve and MR curves for a monopolistically competitive firm. P = 1000 - 2Q MR = 1000 - 4Q Where P is the price of the product and Q is the level of production. For the 200th unit of Q, MR is equal to _______ and demand is price ____________.

a) 200, elastic
b) -200, inelastic
c) 600, elastic
d) -600, inelastic

9. In the long run, firms in a monopolistically competitive industry will
a) earn substantial economic profits.
b) tend to just cover costs, including normal profits.
c) seek to increase the scale of operations.
d) seek to reduce the scale of operations.

10. Assume a monopoly has the following demand schedule: Price........Quantity $20.............200 $15.............300 $10.............500 $5...............700 What can you say about the price elasticity of demand along the demand curve between $15 and $20?
a) Demand is price elastic.
b) Demand is price inelastic.
c) Demand is unitary elastic.
d) There is not enough information to tell.

11. Which of the following statements is correct?
a) Barriers to entry do not affect the industry structure.
b) Barriers to entry affect the competitiveness of an industry because they determine whether or not typical firms in an industry will face new competition if they are earning above normal returns on investment.
c) Barriers to entry are highest for monopolistic competition.
d) Barriers to entry can be achieved only through government mandate.

12. Which of the statements below concerning barriers to entry is FALSE?
a) They restrict entry into industries in which positive economic profits are being made.
b) They are somewhat lessened by the existence of patents.
c) They may be due to legal impediments such as licenses.
d) They may be due to a single firm controlling access to a natural resource or production process.

13. In comparing monopoly to a competitive market, which of the following is FALSE?
a) Market price will be higher under monopoly.
b) Equilibrium quantity will be higher under perfect competition.
c) Consumers will be worse off with the monopoly.
d) Employment will be higher under monopoly.

14. All of the following are possible characteristics of a monopoly except
a) there is a single firm.
b) the firm is a price taker.
c) the firm produces a unique product.
d) the existence of some advertising.

15. ZZZ, Inc. operates in a monopolistically competitive industry. Its demand curve can be written as P = 160 - Q and its short run total cost curve is equal to TC = 1000 + Q^2. What is the rate of output that maximizes ZZZ, Inc.'s short run profits?
a) 40
b) 0
c) 53
d) 20

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