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

1. When prices change by 10 percent, it will decrease the demand for chips by 20 percent and for disk by 10 percent. Therefore, the sale and sales revenue will decrease by 30 percent.

2. We cannot tell which product will generate the most revenue since the prices are unavailable; therefore, additional information about the prices and quantity demanded is needed.

Step-by-step solution

Explanation for part (a)

We know that formula for price elasticity is:

$ep=\frac{△Q}{△P}$

Therefore, the demand for computer chips will get reduced by 20 percent due to 10 percent increase in price, as shown below:

$$\begin{gathered} -2=\frac{△Q}{10} \\ △Q=2\times 10=20 \end{gathered}$$

Similarly; the demand for disks will get reduced by 10 percent due to 10 percent increase in price, as shown below:

$$\begin{gathered} -1=\frac{△Q}{10} \\ △Q=1\times 10=10 \end{gathered}$$

The fall in demand will result in a fall in sales, and therefore, sales revenue.

The sales revenue for the computer chips will get reduced since the fall in demand is more than the rise in the price. Therefore, fewer units will be sold at a high price, and the revenue will consequently fall.

Explanation for part (b)

The elasticities of demand is known, but one needs to know the prices in order to find which product generates the most revenue; therefore, to know which product generates the most revenue, one needs to have additional information.