Question

Question 1 The market demand and supply schedules for a premium Belgian chocolate in Hong Kong are shown as follows: Price per box 5,000 4,500 4,000 3,500 3,000 2,500 2,000 Quantity Demanded (No. of boxes) 3,000 3,500 4,000 5,000 5,300 5,500 9,800 Quantity Supplied (No. of boxes) 8,000 7,000 6,000 5,000 4,000 3,000 2,000 a) Identify the equilibrium price and quantity of the Belgian chocolate. (1 mark) b) (i) Using the average method, calculate the price elasticity of demand of the following price ranges of the premium Belgian chocolate: • • between $3,500 and $4,500; between $2,500 and $3,500. (1.5 marks) (1.5 marks) (ii) (2 marks) Based on your answers in part b) (i) above, what pricing strategy should the chocolate supplier adopt in order to increase its revenue. (iii) Give TWO reasons to explain why the price elasticity of (2 marks) demand for the premium Belgian chocolate may become inelastic.

Answer 1

Question 1

a.) The equilibrium price (P) is $3,500 and quantity (Qd = Qs) is 5,000 boxes.

b.) The price elasticity of demand (PED) using the average or midpoint method is:

Formula:

(Q, - Q,M[(Q, + Q,)/2] (Р,- Р)ДР, + Р)2] Price elasticity of demand = %3D

i.) Between prices $3,500 and $4,500:

Q2 = 3,500, Q1 = 5,000 & P2 = 4,500, P1 = 3,500

PED = -1.4116 (Elastic Demand)

ii.) Between prices $2,500 and $3,500:

Q2 = 5000, Q1 = 5,500 & P2 = 3,500, P1 = 2,500

PED = -0.286 (Inelastic demand)

c.) Based on answers in (b), the elasticity of demand at higher prices, above equilibrium price is elastic, and the prices below equilibrium price are inelastic. This means that lowering the price by $500 will result in less than proportional change in quantity demanded, so if the producer lowers the price below equilibrium price they will not be able to reap the most revenue they could, the same applies for prices above equilibrium price, where the demand curve is elastic, which means that the even a small increase in price will lead to a large drop in quantity demanded. The revenue-maximizing quantity is at the equilibrium price. The pricing strategy that could be used in order to maximize revenues is called skim pricing, this is where the producer could set higher prices at first and skim the prices in time to take advantage elastic demand at higher prices. Skim pricing is a temporal version of price discriminations which could be practised in a kinked demand curve such as the one displayed in the market for premium Belgian chocolate.

d.) Premium Belgian chocolates may display an inelastic demand curve for a certain price range due to it not facing any close substitute for a given quality at a given price. For example, if the producer increases the price from $2,500 to $3,000 the quantity demanded only drops by 200 boxes, as there might not be a close substitute for chocolate of premium quality at that price. Second reason for demand becoming inelastic is if Belgian chocolate becomes a necessity.