Suppose you are the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of $20. On the basis of a survey, you have determined that reducing the price of an average meal to $18 would increase the quantity demanded to 450 per day.(a) Compute the price elasticity of demand between these two points.(b) Would you expect total revenues to rise or fall? Explain.

(a) 1.25 , (b) total revenues shall rise

Explanation:

Price elasticity of demand is a measure of degree of responsiveness of change in quantity demanded to change in price.

Price elasticity of demand is expressed as: ×

wherein, P= original price

              Q= Original quantity demanded

In the given case, it can be calculated as

here we ignore the negative sign.

Price elasticity of demand = 25/20 = 1.25

This conveys relatively elastic demand i.e greater than 1. This means a little change in price would lead to a greater change in the quantity demanded.

Total revenue refers to revenue earned at a given level of output. Here,

Total revenue before =  400 units × $20 = $8000

Total revenue at new price level = 450 units × $18 = $8100

Total revenue has increased. This is because, the elasticity of demand is relatively elastic, so that a decrease in price is exceeded by more than proportionate increase in quantity demanded.

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