Question

The ACME Corporation determines that at current prices, the demand for its computer chips has a price elasticity of -2 in the short run, while the price elasticity for its disk drives is -1 a. If the corporation decides to raise the price of both products by 10 percent, what will happen to its sales? To its sales revenue? b. Can you tell from the available information which product will generate the most revenue? If yes, why? If not, what additional information do you need?

Short answer

A 10% increase in the price of computer chips and disk drives will result in a decrease in sales by 20% and 10% respectively. Due to the price increase, the sales revenue for computer chips is predicted to decrease, while for disk drives it is expected to increase. Additional information such as current prices and quantities sold are required to determine which product will generate the most revenue.

Step-by-step solution

Understand Price Elasticity of Demand

The price elasticity of demand quantifies how much the quantity demanded of a good responds to a change in the good's price. It is calculated as the percent change in quantity demanded divided by the percent change in price. In this case, the price elasticity of demand for computer chips is -2 and disk drives is -1.

Predict the Impact of a Price Increase on Sales

From the given price elasticities, it can be predicted that a 10% increase in the price of both products will lead to a 20% decrease in the quantity demanded for computer chips (10% * -2 = -20%) and a 10% decrease for disk drives (10% * -1 = -10%).

Predict the Impact of a Price Increase on Sales Revenue

Sales revenue is calculated by multiplying the price of a product by the quantity sold. With a price elasticity of demand greater than 1 in absolute value, a price increase will result in a decrease in total revenue, while with a price elasticity of demand less than 1 in absolute value, a price increase will increase total revenue. Thus, revenue from computer chips will decrease while that from disk drives will increase.

Determine the Product Generating Most Revenue

The given information is insufficient to definitively say which product will generate the most revenue only knowing the price elasticity. To determine this, additional information is required such as the current prices, quantities sold, and the projected sales quantities post price increase for both products.

Key concepts

Microeconomics

Microeconomics is a branch of economics that focuses on the behavior of individuals and firms in making decisions regarding the allocation of scarce resources and the interactions among these individuals and firms. One key aspect of microeconomics is understanding how consumers respond to price changes, which is essential for businesses when setting prices for their products or services. The role of microeconomics extends to analyzing market mechanisms that establish relative prices among goods and services and the allocation of limited resources among many alternative uses.

Understanding microeconomics provides the foundation for evaluating market conditions, which in turn can affect a company like ACME Corporation's strategies for pricing computer chips and disk drives. When firms grasp the principles of microeconomics, they can use this insight to make informed decisions that maximize profits and market shares while adhering to consumer demand and price sensitivities.

Demand Response to Price Changes

The demand response to price changes is a crucial concept in microeconomics and can be quantitatively measured by the price elasticity of demand. This metric encapsulates the consumer's sensitivity to price fluctuations concerning their consumption patterns. A higher price elasticity indicates that consumers will significantly reduce the quantity demanded in response to a price increase. In contrast, a lower price elasticity means that the change in quantity demanded will be relatively smaller.

In the instance of the ACME Corporation, the demand for computer chips is highly elastic with a price elasticity of -2, suggesting that consumers will significantly reduce their purchases if the prices rise. Conversely, disk drives have a price elasticity of -1, implying that the demand is less affected by price changes. It is indicative of the fact that disk drives may be a necessity or have fewer substitutes available compared to computer chips.

Sales Revenue Impact

When evaluating the impact of price changes on sales revenue, understanding the price elasticity of demand is fundamental. Sales revenue is the total amount of money that is brought into the company from the sales of goods or services, calculated as the product's price times the quantity sold.

For products with an absolute price elasticity greater than 1 (elastic demand), an increase in price will typically result in a decrease in total revenue because the quantity demanded falls sharply. For products with an absolute price elasticity less than 1 (inelastic demand), raising prices should lead to an increase in total revenue since the quantity demanded does not drop significantly. In the ACME Corporation's scenario, we see that the computer chips, which have an elastic demand, will likely generate less revenue after the price increase. In contrast, disk drives are expected to generate more revenue following the price hike, due to their inelastic demand. However, without concrete figures for pre-adjustment prices and quantities, the exact impact on sales revenue remains uncertain.