Question

The owner of a small chain of gasoline stations in a large Midwestern town read an article in a trade publication stating that the own price elasticity of demand for gasoline in the United States is $\mathbf{-}\mathbf{0}\mathbf{.}\mathbf{2}$. Because of this highly inelastic demand in the United States, he is thinking about raising prices to increase revenues and profits. Do you recommend this strategy based on the information he has obtained? Explain.

Short answer

The price increase will not be a good plan.

Step-by-step solution

Introduction

Highly Inelastic demand means that once the price is fixed, it cannot be affected by other variable and it is applicable for quantity also.

A demand can be highly inelastic if the value of the own price elasticity of demand is zero.

Describe high inelastic demand

According to this case, the own price elasticity of demand for gasoline is$-0.2$. The demand is highly inelastic because there are no substitutes available for the gasoline.

Knowing the situation, the owner is thinking of price increase to increase revenues and profits. If there will be an increase in the price, the demand for the goods will decrease.

Here, the chance is that the consumers will look for cheaper price of gasoline in other stations, which will lead to the major drop of the firm's profit.

Therefore, consumers will have to do a research within the area to know where to purchase gasoline that has cheaper price. And so, increasing the price will not be a good plan.