Question

Price Elasticity of Demand: Chippers Cookie Bakery

Price Elasticity of Demand measurers how changed in a price affect the quantity of the product demanded. Specifically, it is the ratio of the percentage change in quantity demanded to the percentage change in price. In order to understand how to plan a successful pricing program, marketers must understand how elastic or inelastic the consumers are to changes in price. In other words, to what extent will a price increase or decrease result in changes in demand? For some products a price increase may in fact result in a drop in revenue if the quantity demanded declines. However, for that same product a price decrease may actually result in a revenue increase if the quantity demanded rises significantly.

% Change in Quantity Demanded

Price elasticity of Demand = -------------------------------------------------------

% Change in Price

To calculate Percentage Change in Quantity Demanded:

                                                                   Quantity Demanded at T2 − Quantity Demanded at T1

% Change in Quantity Demanded = ---------------------------------------------------------------------------------------------------- × 100

Quantity Demanded at T1

To calculate Percentage Change in Price:

Price at T2 − Price at T1

% Change in Price = ------------------------------------------------------------------------------ × 100

Price at T1

Remember that markets are elastic if the Price Elasticity of Demand is less than -1. Thus, an elasticity of -5 would indicate that a 1% decrease in price produces a 5% increase in quantity sold. But it is important to remember that markets are not always elastic some marketing are inelastic.

In an inelastic demand market, price elasticity of demand is greater than -1. That means that if price elasticity of demand is -.50 then a 1% increase in price results in a ½ percent decrease in the quantity demanded. Inelastic demand markets allow marketers to raise price with fewer customers leaving the market than in elastic demand markets. However, a price decrease will not entice large groups of buyers into the market as they might in an elastic demand market.

In the following exercise, you’ll evaluate the Price Elasticity of Demand.

Read the fictional scenario below, you need to identify the price before the price/increase and quantity demanded before and after the price increase/decrease.

Case:

Chippers is a new cookie bakery founded by sisters Ella and Alexa Gallagher. The sisters loved to bake and had a recipe file full of their Grandmother’s award-winning cookie recipes. The bakery specialized in large cookies. When they were in school the girls would bake and sell cookies to their friends to help pay for books, etc. People always told them that they should go into business. After graduation the girls decided to do just that and open Chippers, since that is what their Grandmother called her chocolate chip cookies. There was just one problem they knew what to charge their friends when they only made a dozen or two dozen cookies, but figuring out what to charge per cookie in their bakery was more complicated. They finally decided on a price and have not adjusted that price since they opened three months ago.

Ella and Alexa’s customers have been telling them that they love their cookies but not their prices. They finally thought to ask, what customers disliked about the price and the found out the people thought their prices were high for the size of the product. After reviewing their expenses, the girls realized that they really were charging more than they needed to for each cookie. But, the girls were worried that lowering prices would mean a drop in revenue and that they would earn less money.

After thinking about it for a while the girls decided to run a promotion and lower the price of their cookies for one week and hoped the customers kept coming and more would come. They agreed to lower the price for each cookie .50c. After a week of the new price they will evaluate whether to keep the price lowered.

Time Period	Price/unit	Quantity Demanded
T1 (original Price)	$2.50	4500
T2 (new Price)	$2.00	5700

1. What is the percentage change in price”?

  (Click to select)   20%   10%   30%   -10%   -20%

2. What is the percentage change in quantity demanded?

  (Click to select)   25.6%   24.6%   26.6%   -25.6%   -26.6%

3. What is the Price Elasticity of Demand?

  (Click to select)   1.33%   2.33%   3.33%   -1.33%   -2.33%

4. Did sales increase as a result of the price decrease?

  (Click to select)   Yes, sales increased.   No, sales did not increase.   It is impossible to determine based on the information provided.

5. Is the market for Chippers elastic or inelastic?

  (Click to select)   Elastic   Inelastic   Neither elastic nor inelastic   It is impossible to determine based on the information provided.

6. Would this price decrease result in a revenue increase or decrease for the firm?

  (Click to select)   Increase   Decrease   There would be no impact on revenue.   It is impossible to determine based on the information provided.

Answer 1

$\large Elasticity, E = \frac{\% \triangle Q}{\% \triangle P}$

Given,

	Price per unit	Quantity Demanded
T1	$ 2.50	4500
T2	$ 2.00	5700

1. Percentage change in price

$\large \% \triangle P = \frac{P_2-P_1}{P_1}*100$

$\large \% \triangle P = \frac{2-2.5}{2.5}*100$

$\large \% \triangle P = \frac{-0.5}{2.5}*100$

$\large \% \triangle P = - 20\%$

2. $\large \% \triangle Q= \frac{Q_2-Q_1}{Q_1}*100$

$\large \% \triangle Q= \frac{5700-4500}{4500}*100$

$\large \% \triangle Q= \frac{1200}{45} = 26.66\%$

3. Price Elasticity = $\large \frac{\% \triangle Q}{\% \triangle P}$

$\large e = \frac{26.6\%}{-20\%}$

Elasticity = - 1.33

4. Yes the sales increased due to price decrease.

5. It is elastic (since price elasticity of demand is greater than 1)

6. The total revenue will increase due to the price decrease. In case of elastic demand lower the price higher the revenue.

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