Quiz 3: Demand Analysis
Marginal revenue is the change in the total revenue by selling an additional unit of output. The change in the total revenue, that is, the marginal revenue from the fourth shirt per day is . Three shirts were sold at a price of $45 per shirt while four shirts are sold at $44 per shirt per day. Thus, the price reduction necessary to sell four rather than three shirts per day is .
a. The cross price elasticity of demand measures the responsiveness of changes in quantity demanded of good due to the changes in the price of related good (substitute or complement). The arc-cross price elasticity of demand measures the cross price elasticity between two prices of the related good. It is calculated as …… (1) The original and new quantity demanded of Potomac's ovens are and , respectively. The original and new price of Spring City ovens are and , respectively. Substitute appropriate values in (1). Thus, the arc-cross price elasticity of demand between Potomac's ovens and Spring City ovens is . b. Positive arc-cross price elasticity of demand between Potomac's ovens and Spring City ovens indicates that they are substitutes and thus these are quite close competitors. Factors such as change in the price of Potomac's ovens, income of the target consumers, level of advertising, tastes and preferences of the consumers are likely to influence the observed relationship between Potomac's ovens and Spring City ovens. c. The price elasticity of demand measures the responsiveness of change in quantity demanded to change in price. The arc price elasticity of demand measures the price elasticity between two prices of the good. It is calculated as …… (2) The arc price elasticity of demand for Potomac's ovens is . At the price of $600, Potomac oven is able to sell 4500 units. Calculate the new price at which Potomac is able to sell 6000 units as follows: Substitute appropriate values in (2) and rearrange to find . Thus, Potomac should charge to keep the demand for its ovens same as it was before the Spring City ovens price cut. Note: The $500 is the cost and not the price. Since Potomac over and Spring city ovens are perfect substitutes, it is assumed that its price are same as Spring city price before price cut.
Operating profit is the profit derived out of operations excluding the interest rate and other taxes. This can be calculated as Calculate the operating profit for 4 th shirt, Therefore, operating profit for production at 4 th shirt is $64. Now, calculate the operating profit for 3 rd shirt, Therefore, fourth shirt earns an operating profit, which is $13 large.