When the price of a toy was $45, a store sold 200 units in one week. Then the store reduced the price of the toy to $20.00 As a result, sale of the toy increased to 25 units in one week. (a). Calculate price elasticity of demand (5 points). You must show the calculation here. Do not try to copy and paste. (b). Interpret your results (5 points)
Price elasticity of demand (PED) is a fundamental concept in economics that measures the responsiveness of the quantity demanded of a product to changes in its price. It provides insights into consumer behavior and helps businesses make informed pricing decisions. In this essay, we will calculate the price elasticity of demand for a toy sold by a store, which initially priced it at $45 and later reduced it to $20, resulting in changes in the quantity sold.
To calculate the price elasticity of demand (PED), we will use the following formula:
PED = (% Change in Quantity Demanded) / (% Change in Price)
Step 1: Calculate the percentage change in quantity demanded. Initial quantity demanded (Q1) = 200 units New quantity demanded (Q2) = 25 units
% Change in Quantity Demanded = [(Q2 – Q1) / Q1] * 100 % Change in Quantity Demanded = [(25 – 200) / 200] * 100 % Change in Quantity Demanded = (-175 / 200) * 100 % Change in Quantity Demanded = -87.5%
Step 2: Calculate the percentage change in price. Initial price (P1) = $45.00 New price (P2) = $20.00
% Change in Price = [(P2 – P1) / P1] * 100 % Change in Price = [($20.00 – $45.00) / $45.00] * 100 % Change in Price = [(-$25.00) / $45.00] * 100 % Change in Price = -55.56%
Step 3: Plug the percentage changes into the PED formula.
PED = (-87.5%) / (-55.56%) PED ≈ 1.57
The calculated price elasticity of demand (PED) for the toy is approximately 1.57.
Elastic Demand (PED > 1): A PED greater than 1 indicates that the product is elastic, meaning that consumers are relatively responsive to price changes. In this case, a 1% decrease in price leads to a 1.57% increase in quantity demanded. The store experienced a substantial increase in sales when it reduced the price of the toy.
Short-Run vs. Long-Run: It’s important to note that price elasticity of demand can vary in the short run and the long run. In the short run, consumers may be less responsive to price changes due to factors like immediate need or lack of alternatives. In the long run, elasticity might be higher as consumers have more time to adjust their purchasing behavior.
Pricing Strategy Implications: The store’s decision to reduce the price of the toy from $45.00 to $20.00 was effective in boosting sales. However, the relatively elastic demand suggests that the store could further optimize its pricing strategy. For example, a slight price increase might result in a proportionally larger revenue increase, while a significant price hike could lead to a substantial drop in sales.
In conclusion, the price elasticity of demand (PED) is a valuable metric for understanding how consumers respond to price changes. In this case, the toy exhibited elastic demand, indicating that consumers are sensitive to price fluctuations. The store’s decision to lower the price resulted in a notable increase in sales. However, further analysis and experimentation with pricing strategies could help the store maximize its revenue and profitability while considering the elasticity of demand.
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