Relationship between elasticity and total revenue
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You are the Chief Financial Officer of Heavy Buds and are faced with the task of raising sales revenue per the units sold by your firm. Heavy Buds sold 120 million packs of beer annually at $3 per pack. The Chief Executive Officer suggested that you could raise an additional $120 million in annual revenue from any different quantity you sell by raising the price by $1 per pack of beer. What would you say about the prospects for raising $120 million in additional revenue?
Immediately after you heard the decision to raise the price of a pack by $1, you performed a market analysis on the demand Heavy Buds faces and its supply function, you discovered that:
a) The price-elasticity of the demand for beer facing Heavy Buds = -1.
b) Heavy Buds Supply function is perfectly elastic.
Give a precise answer to whether:
a) the suggested price increase by $1 will raise additional revenues by $120 million from whatever units will be sold,
b) why yes and why not, and
c) if the suggested price increase were incorrect, what should the correct one be?
d) verify that your answer is consistent with an elasticity of demand that equals to -1.
Use the mid-point formula to verify your answer.
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Solution Summary
Price elasticity of demand influencing firms' pricing strategy. If a product is elastic in relation to its price, firm has to decrease its price in order to increase its revenue. On the other hand if the product is inelastic, price has to be increased to increase the revenue. If the price elasticity of demand is unit elastic, changes in price has no effect on its revenue. In the market whereby, the supply is perfectly elastic and price elasticity of demand is unit elastic, firm should not change its price to increase its revenue. The firm should maintain its market share by maintaining its price. To get additional revenue, the firm should capture consumer surplus by price discrimination strategy.
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refer to the attachment
The initial price (P1) is $3
The initial quantity (Q1) sold at P1 is 120 million packs (120M)
The suggested new price (P2) is $4 (ie $1 increment)
The price elasticity of demand is -1, ie unit elastic
The first step is to find out how many quantity of beer will be sold given the new price of $4. We make use of the information on the price of elasticity of demand = -1 to calculate the new quantity (Q2) sold.
The formula for price elasticity of demand is: (%∆Q)/(%∆P)
With some manipulation this can be ...
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