Question

Economics - Pricing

Justin has been selling 4,600 T-shirts per month for $6.50. When he increased the price to $7.50 he sold only 4,000 T-shirts.

a. What is the demand elasticity? If his marginal cost is $4 per shirt, what is his desired markup and what is his initial actual markup?

b. Was raising the price profitable?

Answer 1

We have Q1 = 4,600 and P1 = $6.50, P2 = $7.50 and Q2 = 4,000 T-shirts.

a. Use mid point method

ed = (Q2 – Q1) / [(Q2 + Q1)/2] / (P2 – P1) / [(P2 + P1)/2]

= (4000 - 4600)/((4000 + 4600)/2) divided by (7.50 - 6.50)/((6.50 + 7.50)/2)

= -0.9767

Hence demand elasticity is around -0.98

Here MC is $4 per shirt,

Desired markup = 1/2 = 0.5

Initial actual markup = (P - MC)/P

= (6.50 - 4.00)/6.50

= 0.385

b. Demand elasticity is less than 1 which means when price is increased revenue is increased. Since cost is unchanged this implies profits will also increase. Hence raising price is profitable.