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Using price elasticity of demand to evaluate a price cut

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Royersford Knitting Mills, Ltd., sells a line of women's knit underwear.
The firm now sells about 20,000 pairs a year at an average price of $10 each. Fixed costs amount to $60,000, and total variable costs equal $120,000. The production department estimates that a 10 percent increase in output would not affect fixed costs but would reduce average variable cost by 40 cents. The marketing department advocates a price reduction of 5 percent to increase sales, total revenues, and profits. The arc elasticity of demand with respect to prices is estimated at -2.

Evaluate the impact of the proposal to cut prices on (i) total revenue, (ii) total cost, and (iii) total profits.

If average variable costs are assumed to remain constant over a 10 percent increase in output, evaluate the effects of the proposed price cut on total profits.

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Solution Preview

See the attached file. The price elasticity of demand is -2, so a price reduction of 5% will result in 10% increase in demand. This means that Royersford will sell all of its increased ...

Solution Summary

This solution shows how to calculate the effects of a price cut when a firm's price elasticity of demand is known. Illustrated with a spreadsheet file that shows all the calculations.

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I have never had to use this before, but I am running into dead ends.Please help me.
I am working on a essay from questions for school and I need a little help. I have answered most of my paper, but I have 4 that I need help with.
I have chosen Wal-Mart as the company to use in my paper.
1) Is this company operating in a perfectly competitive market? Why or why not?
I believe that this would be no because the prices can change so drasticly due to competition. Is that correct?
2) If the owner of the company asked you to assess whether or not they were using the optimal amount of an input (given a set price for that input), what economic criterion would you use in your analysis?
I am totally lost here. They gave us simulations in class to play with, but I am having trouble understanding how the simulations went along with this question.
3) If you were asked to assess the economic profitability of this company, what economic tools would you use in your analysis?
I am not sure understand what it means by tools. Would this be finacial statements?
4) What is the elasticity of demand for the product (or one of the products) that is produced by the company? Given this elasticity of demand, how should the company price their product in this market? Give justification for your answer.
Would it be strategic pricing to go along with the competition to increase sales?
Thank you for your time and help.

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