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Basic Question about Price Elasticity

Basic Question about Price Elasticity. Ted Mitchell. Any Questions About Price Elasticity. Review Questions Very Badly done on the last final. 1) If you know the price P* that maximizes revenue, then adding the variable cost of the product to the P* will be the price that maximizes profit.

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Basic Question about Price Elasticity

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  1. Basic Question about Price Elasticity Ted Mitchell

  2. Any Questions About Price Elasticity

  3. Review Questions • Very Badly done on the last final

  4. 1) If you know the price P* that maximizes revenue, then adding the variable cost of the product to the P* will be the price that maximizes profit. • a) True • b) False

  5. 1) If you know the price P* that maximizes revenue, then adding the variable cost of the product to the P* will be the price that maximizes profit. • a) True • b) False * • Remember the definition of the price that maximizes profit, Pz* is more fair than a cost-based price • Pz* = a/2b + V/2 = Pr* + V/2

  6. 2) If the firm is charging a price that maximizes profit, then the elasticity of price will be elastic and more negative than -1. • a) True • b) False

  7. 2) If the firm is charging a price that maximizes profit, then the elasticity of price will be elastic and more negative than -1. • a) True* • b) False

  8. Dollars Elasticity, Eqp = %∆Q/%∆P -0.5 -1 -2 -3.0 Maximum Revenue Maximum Profit Selling Price Pr* Pz*

  9. 3) When your firm has a product with a variable manufacturing cost, then there is a range of prices in which your revenues can decrease while your profits increase. • a) True • b) False

  10. 3) When your firm has a product with a variable manufacturing cost, then there is a range of prices in which your revenues can decrease while your profits increase. • a) True * • b) False

  11. Dollars Elasticity, Eqp = %∆Q/%∆P -0.5 -1 -2 -3.0 Maximum Revenue Maximum Profit Selling Price Pr* Pz*

  12. 4) A Markup on Price can be greater than 100% • a) True • b) False *

  13. 4) A Markup on Price can be greater than 100% • a) True • b) False * • Remember the definition • Mp = (P-V)/P • As P get larger what happens

  14. 5) The price that maximizes profit is always greater than or equal to the price that maximizes revenue. • a) True • b) False

  15. 5) The price that maximizes profit is always greater than or equal to the price that maximizes revenue. • a) True * • b) False

  16. Dollars Elasticity, Eqp = %∆Q/%∆P -0.5 -1 -2 -3.0 Maximum Revenue Maximum Profit Selling Price Pr* Pz* Pz ≥ Pr

  17. 6) It would be unusual for a firm to maintain a price that was on the inelastic portion of the demand curve because an increase in price would result in more revenues and more profits. • True • False

  18. 6) It would be unusual for a firm to maintain a price that was on the inelastic portion of the demand curve because an increase in price would result in more revenues and more profits. • True* • False

  19. Dollars Elasticity, Eqp = %∆Q/%∆P -0.5 -1 -2 -3.0 Maximum Revenue Maximum Profit Selling Price Pr* Pz* Inelastic Elastic

  20. 7) When elasticity is measured at two very different price points, it can be a estimation error. It is best to use a measure of arc elasticity rather than point elasticity when the changes in price are large. • A) True • B) False

  21. 7) When elasticity is measured at two very different price points, it can be a estimation error. It is best to use a measure of arc elasticity rather than point elasticity when the changes in price are large. • A) True • B) False

  22. Quantity Sold The starting point (Q1=3,000, P1 = $4) The revenue is P x Q = $12,000 Q1 = 3,000 X X P1 = $4 Price per Unit TJM

  23. Quantity Sold The end point (Q2= 2,500, P1 = $5) The revenue is P x Q = $12,500 Q1 = 3,000 X Q2 = 2,500 X P1 = $4 Price per Unit P2 = $5 TJM

  24. Estimating Arc Elasticity • The price in period 1 was P1 = $4 and the quantity sold was Q1 = 3,000 units. The price in period 2 was P2 = $5 and the quantity sold was Q2 = 2,500 units • What is the arc elasticity?

  25. Using the minimum value in the denominator gives the same as the ratio of the two impacts • The impact of change in quantity divided by the impact of the change in price • Arc elasticity = I∆Q/I∆P

  26. Are the mathematics different? • You are an independent sales person who works with several different firms as a manufacturer’s agent selling their products to your customers. One of your manufacturers has offered you the opportunity to sell a new pump to your customers. The manufacturer will bill you for $180 for every pump you sell and will ship the pump directly to your customer. You need a 60% sales commission on this type of product to stay in business. You must set the selling price that the customer will pay you for the pump. What selling price must you set for the pump if you must make a 60% commission on the selling price?

  27. Are the mathematics different? • You bought a pump for $180. You need a profit that gives you the normal and fair markup on price of 60%. What is the selling price you must charge?

  28. Are the mathematics different? • You bought a pump for $180. You need a profit that gives you the normal and fair markup on price of 60%. What is the selling price you must charge? • Sales Commissions % and Markup % are both calculated on selling price

  29. Price setting using the cost-based markup method What price do you charge? • You are told Mp = 0.60 and V = $180 • Mp= (P-V)/P • 0.60 = (P-180)/P • 0.60P =P-180 • P-0.06P = 180 • P = 180/(1-0.6) or P = V/(1-Mp) • P = 180/0.4 = $450

  30. You have to be able to calculate • Markup on price • Set a cost-based price using markup • Markup on Cost • Convert from one to the other • Know how to calculate them in a channel of distribution

  31. A manufacturer makes coats for a cost of $40 each and sells them to a wholesaler. The price he charges the wholesaler earns him a 30% markup on price. • The wholesaler sells the coats to a retailer. • The retailer sells the coats to consumers for $180 that earns him a 125% markup on his cost for the coats. • What is the dollar markup earned by the wholesaler?

  32. A manufacturer makes coats for a cost of $40 each and sells them to a wholesaler. The price he charges the wholesaler earns him a 30% markup on price. • The wholesaler sells the coats to a retailer. • The retailer sells the coats to consumers for $180 that earns him a 125% markup on his cost for the coats. • What is the dollar markup earned by the wholesaler? = (P-V) or (price to the retailer – price to the wholesaler)

  33. What is the price to the retailer? • The retailer sells the coats to consumers for $180 that earns him a 125% markup on his cost for the coats. • What is the markup on price? • 125 = 125/100 converts by adding top part to the bottom part = 125/225 = 55.56% • Retailer’s profit = 180 x 55.56 = $100 • Retailer’s cost is P – V = 180 – 100 = $80

  34. A manufacturer makes coats for a cost of $40 each and sells them to a wholesaler. The price he charges the wholesaler earns him a 30% markup on price. • The wholesaler sells the coats to a retailer. • The retailer sells the coats to consumers for $180 that earns him a 125% markup on his cost for the coats. • What is the dollar markup earned by the wholesaler? = (P-V) or ($80 – price to the wholesaler)

  35. A manufacturer makes coats for a cost of $40 each and sells them to a wholesaler. The price he charges the wholesaler earns him a 30% markup on price. • What is the price to the wholesaler? • What is manufacturer’s selling price? • P = V/(1-Mp) • P = $40/(1-30%) = $57.14

  36. A manufacturer makes coats for a cost of $40 each and sells them to a wholesaler. The price he charges the wholesaler earns him a 30% markup on price. • The wholesaler sells the coats to a retailer. • The retailer sells the coats to consumers for $180 that earns him a 125% markup on his cost for the coats. • What is the dollar markup earned by the wholesaler? = (P-V) or ($80 – $57.14) =$22.86

  37. Channel Markup problem does • It makes you demonstrate that you understand how to set price usingMarkup on Price • Different from Markup on cost • How to convert from one to the other.

  38. Good Luck on Monday • Ted

  39. Convenient to consider price elasticity constant in the current region e is the price elasticityand it is same for every price k is a scaling constant Q Q Q = a-bP Q = kPe P P

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