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Davis, Spring 2006

E303, Problem Set #5

1. Chez What has recently opened a stand between the Commons and the
School of Business. They sell mostly breakfast items, particularly coffee, and
croissants. The operators are particularly concerned about the demand for
croissants. In an effort to assess the wisdom of their pricing strategy, they
asked an economist client to estimate the demand for croissants sold at Chez
What. He came with the following information.
Q = 102-2P - 10Pc + 15Pa
Where P = the price of croissants, P c = the price of coffee sold at Chez What,
and Pa = the price of coffee sold at the nearby Alpine bagel bakery
a. Suppose that the price of coffee at Chez What is $1 and that the price of
coffee at the Alpine Bagel Bakery is $2 per cup. Calculate the inverse
demand curve (e.g., express price as a function of quantity).


Inverse demand _________________________________

For parts b and c assume that the price of croissants is $1.
b. Calculate the point price elasticity of demand. Would Chez What increase
profits by Raising the price of croissants?


Raise Price?


c. Calculate the cross price elasticity of demand for croissants with respect to
the price of coffee. How is coffee related to croissants? Why?


2. Joe is evaluating the marketing strategy at his restaurant and inn. Suppose
that in response to a $2.00 off" sales promotion for Spaghetti dinners, Joe
finds that nightly dinner sales increase from 20 per night to 40. Normally,
the dinners sell for $6.00.
a. What is the arc price elasticity of demand?


b. Would Joe increase revenues by further reducing the price? What

about profits? Explain.
Price reduction prompts revenue increase
Price reduction prompts profit increase

Y / N / Cant tell
Y / N / Cant tell

Explanation _____________________________________________

3. Fred McCutchen a new employee at McCutchoni Frozen Foods estimates that the
price elasticity of demand for McCutchoni Frozen Pizzas to be -1.5, as
compared to a price elasticity of demand for frozen pizzas in general of -2.34.
In light of the relative inelasticity of McCutchoni Frozen Pizza's, Fred
recommends raising the price to increase sales revenues. You, a more
experienced member of the firm, are suspicious of Joe's estimate, and are
skeptical of his recommended plan of action? Why? (Hint: Think about the
determinants of price elasticity of demand)
Reason to suspect Freds
Reason to doubt Freds plan of action