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A local coffee shop charges €2.50 for an espresso.
The owner of the coffee shop wants to increase his total revenue.
A recent market research shows that the price elasticity of demand for espresso is about 1.80.
Should the coffee shop lower or raise the price of espresso? Explain your answer.
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DEFINITION
Price elasticity of demand is a measurement of the change
in the consumption of a product in relation to a change in its price.
Thus in this problem = 1.8. (1)
It means, if to follow to the problem LITERALLY, that the dependence Q(consumption)
of P(price) has the form Q = 1.8*(P-2.50).
But it is clear that it is ILLOGICAL: according to (1), if the price rises over €2.50,
the consumption should increase.
So, actually it should be Q = -1.8*(P-2.50),
and my first inference that the "problem's composer" is not able to formulate his "economics problem" correctly.
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| But, thanks to god, I have my common sense |
| in my mind, so I am able to interpret it correctly. |
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Next, I will not consider a profit (since I have no data for calculating it),
and will consider the REVENUE, only. The revenue is
R = P*Q = -1.8*P*(P-2.50), (2)
and our goal (the goal of the coffee shop, from the context) is to increase the revenue (2).
We write the revenue (2) in equivalent form
R = -1.8*P^2 + 1.8*2.50*P.
The derivative is -2*1.8P + 1.8*2.50, and at the price P= 2.50€ it is
= -2*1.8*2.50 + 1.8*2.50 = -4.5.
Since this derivative is negative, then, if the coffee shop wants to increase the revenue, it should decrease the price from €2.50.
Solved, with complete explanations.
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I answered question "a" ONLY,
and my advise to the visitor is NEVER pack more than one problem/question per post,
in accordance with the rules of this forum (and in accordance with the rules of common sense, too).