Theory question 102
ElasticityThe management of a fruit juice production company was directed by the shareholders to increase the revenue from the sale of its product. The management decided to increase the price of the fruit juice from $7 to $10 per unit and this led to a fall in quantity demanded from 150 units to 30 units. Use the information above to answer the questions that follow.
(a) Calculate the: (i) percentage increase in the price; (ii) percentage decrease in the quantity demanded; (iii) coefficient of price elasticity of demand for the fruit juice.
(b) Is the demand for the fruit juice, price elastic or inelastic? Give a reason for your answer.
(c) Did the management of the company achieve its objective of increasing revenue? Explain your answer.
(d) From your answers in 2(a)(iii), was the increase in the price of the fruit juice a rational strategy to employ in order to increase revenue? Explain your answer.
Show the model answer
(a)(i) (10 − 7)/7 × 100 ≈ 42.9%
(ii) (150 − 30)/150 × 100 = 80%
(iii) Ed = 80 ÷ 42.9 ≈ 1.87 (ignoring the minus sign)
(b) Elastic: the coefficient is greater than 1 (quantity fell by a larger percentage than price rose).
(c) No. Revenue before = 7 × 150 = $1,050; after = 10 × 30 = $300; revenue fell by $750.
(d) No. With elastic demand, raising price reduces total revenue; to increase revenue the firm should have lowered the price (or not raised it).
With elastic demand, price and total revenue move in opposite directions.