Question

In attempt to increase revenue and profits, a firm is considering a 4 percent increase in price and 11 percent increase in advertising. If the price elasticity of demand is -1.5 and the advertising elasticity of demand is +0.6, would you expect an increase or decrease in total revenues?

Answer 1

Price elasticity of demand (PED) = -1.5

% increase in price = 4%

$PED=\frac{\% change indemand}{\%change in price}$

$-1.5=\frac{\% change indemand}{0.04}$

% change in demand = -1.5*0.04 = -6%

This means 4% increase in price will result as 6% decrease in demand.

Now, estimate impact of increase in advertising expenditure.

Advertising elasticity of demand (AED) = 0.6

% increase in advertising expense = 11%

$AED=\frac{\% change indemand}{\%change in advertising expense}$

$0.6=\frac{\% change indemand}{0.11}$

% change in demand = 0.6*0.11 = 6.6%

This means 11% increase in advertising expenditure will result as 6.6% decrease in demand.

Based on this, overall it can say that total revenue will increase by 0.6% in case of firm is conducting a 4 percent increase in price and 11 percent increase in advertising.