Quiz 3: Demand Analysis

Business

Marginal revenue img is the change in the total revenue img 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 img . 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 img .

a. The cross price elasticity of demand img measures the responsiveness of changes in quantity demanded of good img due to the changes in the price of related good img (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 img …… (1) The original and new quantity demanded of Potomac's ovens img are img and img , respectively. The original and new price of Spring City ovens img are img and img , respectively. Substitute appropriate values in (1). img Thus, the arc-cross price elasticity of demand between Potomac's ovens and Spring City ovens is img . 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 img 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 img …… (2) The arc price elasticity of demand for Potomac's ovens is img . 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 img . img img Thus, Potomac should charge img 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 img Calculate the operating profit for 4 th shirt, img Therefore, operating profit for production at 4 th shirt is $64. Now, calculate the operating profit for 3 rd shirt, img img Therefore, fourth shirt earns an operating profit, which is $13 large.