Question

George has been selling 5,000 T-shirts per month for $8.50. When he increased the price to $9.50, he sold only 4,000 T-shirts. Which of the following best approximates the price elasticity of demand?

a. -1.8
b. -2
c. -2.6
d. -2.2

Suppose George's marginal cost is $5 per shirt. Before the price change, George's initial price markup over marginal cost was approximately___________ . George's desired markup is__________ . Since George's initial markup, or actual margin, was___________ than his desired margin, raising the price was________ .

Answer 1

Answer: 1. a. -1.8

Step-by-step explanation:

1. Price Elasticity of Demand checks the effect that a price change has on the demand for the good.

It is calculated by;

= ((New Quantity - Old Quantity) / (New Price - Old Price) ) * Old Price / Old Quantity

= ( (4,000 - 5,000) / (9.5 - 8.5 )) * 8.5/5,000

= -1,000/1 * 8.5/5,000

= -1.70

2. Initial Markup

Marginal cost was $5 and he was selling at $8.50 so his initial Markup was;

= (8.5 - 5) / 5

= 70%

Desired Markup is the new price over the marginal cost.

= (9.5 - 5) / 5

= 90%

Actual Margin

= 5,000 * $3.5 (profit)

= $17,500

Desired Margin

= 4,000 * $4.5

= $18,000

Actual Margin was LESS than Desired Margin so raising the price was PROFITABLE