Elasticity

4. a. In cases when Elasticity = 1 or the percentage change in quantity demanded equals to the percentage change in price, neither an increase nor decrease in price would amount to increased total revenue. As an illustration, consider the following demand schedule for pizza:

Price (Px) Quantity Demanded (Qx) Total Revenue (Px X Qx)

P6/slice 10 slices P60

P10/slice 6 slices P60

Price Elasticity = (10-6)/(10+6) = 1

(10-6)/(10+6)

Using above computation, we can see that no amount of change in the total revenue given an increase in the price of pizza. Same is true when the price declines the same percentage as the increase in quantity demanded.

b. If Elasticity is less than one (1), demand for the product is relatively inelastic. Since quantity demanded reacts at a minimum to a change in price, a price increase would actually work in increasing total revenue. A revised computation of the previous example can illustrate this effect.

Price (Px) Quantity Demanded (Qx) Total Revenue (Px X Qx)

P6/slice 10 slices P60

P10/slice 8 slices P80

Price Elasticity = (10-8)/(10+8) = .44

(10-6)/(10+6)

The increase in price, which is 67% overweighed the decrease in quantity demanded of 20% resulting to a 33% increase in total revenue.

c. For an Elasticity of greater than one (1) or when the change in price corresponds to greater change in quantity demanded, a price reduction would be most appropriate to increase total revenue.

Price (Px) Quantity Demanded (Qx) Total Revenue (Px X Qx)

P6/slice 10 slices P60

P5/slice 18 slices P90

Price Elasticity = (18-10)/(10+18) = 1.14

(10-6)/(10+6)

In this particular example, a one-peso reduction in price resulted to eight-unit increase in quantity demanded. Total revenue rose to P90, a 50% rate increase from previous price of P6.

6. a. At a point where P < AC but P > AVC, a firm suffering losses is better off continue operating since total revenue can still cover up total variable cost and portion of the fixed cost, thus, minimizing losses. At any given level of output, the firm can still realize operating profit to offset part of the fixed cost. Consider the following sample data for a computer rental shop:

Price per hour = P25

Total Sales Hours = 500

Total Revenue (P25 X 500) = P12,500

Labor cost = P8,000

Supplies = P2,000

Total Variable cost = P10,000

Rental = P1,200

Electricity = P3,000

Total Fixed Cost = P4,200

In this example, the computer rental shop charges a price which is lower than the average cost of P28.40/hr ({P10,000+P4,200}/500) but slightly higher than the average variable cost of P20/hr (P10,000/500). If the shop will continue to operate, it would have paid the entire variable cost and cover almost 60% of the total fixed cost and suffer a loss of only P1,700 (P12,500 - {P10,000+P4,200}) as compared to the loss in shutting down of P4,200.

b. With the condition that P < AC but P = AVC, the firm is indifferent between continuing its operation and shutting down because either would result to a loss equal to the total fixed cost. To illustrate, suppose the price per hour of rental in our computer rental shop dropped to P20/hr. With a total revenue of P10,000 (P20 X 500), the shop will be able to pay all the variable cost if it continue operating and suffer a loss of P4,200, the amount of total fixed cost. If it happens that the decide to shut down operations, it would still incur the same amount of loss