Question

Suppose you come home from having earned your degree at CSUEB. Your parents own a local chain of fitness clubs that have a great reputation. Your father uses cost-plus pricing, and at the moment he is charging $200 for an annual membership, and is currently selling 800 memberships. Your parents are quite happy with their current markup above average costs

You suspect that perhaps they could be doing better and be more profitable. As you just took ECON 380, you are well equipped to assess this! After consulting with the club's manager, you learn that the cost function for annual memberships is given by c(Q)=1000+20Q+(1/20)Q². Further, they tell you that the own price elasticity of demand is approximately-2.5
Are your parents choosing a membership price that is maximizing profit? if not, what would you suggest-increase the price or reduce the price? Explain. (Hint, relate back to Lecture 12).

Answer 1

Your parents should lower the price of fitness club memberships due to a high price elasticity of demand (-2.5) to maximize revenue. For the pharmaceutical company, advise a price decrease if elasticity is 1.4, an increase if 0.6, and keep the same if 1. Gasoline price elasticity of supply is crucial for companies like UPS or FedEx that rely on fuel.

Step-by-step explanation:

If the own price elasticity of demand for your parents' fitness club memberships is approximately -2.5, then the current pricing strategy is not maximizing profit. The elasticity value indicates a highly elastic demand, meaning consumers are very responsive to price changes. Since the absolute value of elasticity is greater than 1, lowering the price would increase the total revenue because the percentage change in quantity demanded would be greater than the percentage change in price.

In comparison, for the pharmaceutical company with a price elasticity of demand of 1.4, you would advise a price reduction to maximize revenue, as the demand is elastic. If the elasticity were 0.6 (inelastic), a price increase would be recommended. However, with an elasticity of exactly 1, no price changes should be made as revenue is maximized at the current price.

For UPS or FedEx, the gasoline price elasticity of supply indicates how sensitive the market supply of gasoline is to price changes. A high elasticity means supply can quickly adjust to price changes, which is important for companies relying heavily on fuel. They must manage this volatility and hedge against potential fuel price fluctuations that can affect operating costs.