Analyzing Price Elasticity and Profit Maximization Strategies

The assignment delves into the concept of price elasticity of demand using the mid-point method to determine the responsiveness of quantity demanded relative to price changes. A calculated elasticity value suggests that demand is relatively elastic, indicating a significant change in quantity demanded with slight price variations. The implications for business strategy are explored, emphasizing revenue effects of price adjustments. Additionally, the assignment examines profit maximization strategies employed by firms, contrasting approaches using marginal revenue and cost against total revenue and cost methods. It illustrates how equilibrium points, where marginal revenue equals marginal cost or when the difference between total revenues and costs is maximized, guide firms in determining output levels that maximize profits.

Running Head: ECONOMIC PRINCIPLES
Economic Principles
Name of the Student
Name of the University
Author note

1ECONOMIC PRINCIPLES
Table of Contents
Answer 1....................................................................................................................................2
Answer 2....................................................................................................................................4
Answer 3....................................................................................................................................8
Answer 4..................................................................................................................................10
Answer 5..................................................................................................................................11
References................................................................................................................................13

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Answer 1
a)
Figure 1: Fuel-efficient car market
(Source: as created by Author)
When petrol price increases following a shortage of supply, then people are more
willing to use fuel efficient cars as it require less petrol (Krugman et al. 2015). Accordingly,
the demand curve will shift to the right to D1D1. At the old equilibrium price P1, the new
demand creates car shortage of the amount (Q3 – Q1). With new demand, the supply and
demand balances at E2. This is the new equilibrium point with price P2 and equilibrium
quantity Q2.
b)

3ECONOMIC PRINCIPLES
Figure 2: Car market using petroleum substitute
(Source: as created by Author)
When petrol price rises then demand for petrol substitute fuels increases. This will
increase the demand for cars that use liquid gas. An outward shift of the demand curve to
D1D1, reflects this change in demand. At the existing equilibrium price P*, this creates an
excess demand or shortage of these cars equals to (Q2 – Q*). The balance between new
demand and the existing supply curve SS is indicated by the new equilibrium point E1. At E1,
there is a higher price P1 and a larger number of cars Q1 in the market.

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Answer 2
a)
Figure 3: effect of a rise in income
(Source: as created by Author)
Beef is considered as a normal good. For a normal good, when income increases then
demand increases shifting the demand curve rightward from DD to D1D1. At the increased
demand there will be a shortage of beef of the amount EF. A new equilibrium E1 is defined
where new demand curve D1D1 matches with supply curve SS. The new equilibrium is
associated with a high price and high equilibrium quantity of beef.

5ECONOMIC PRINCIPLES
b)
Figure 4: Effect of high quality cattle feed
(Source: as created by Author)
The high quality cattle feed makes more cattle available at the given time. Therefore,
the farmers can now supply more cattle. The increase in supply is seen from the outward shift
of the supply curve from SS to S1S1. The increased supply causes a surplus in the market as
shown as E1G. There is initially no change in the beef demand. Therefore, the new
equilibrium is attained by restoring balance between new supply and old demand (Blad and
Keiding 2014). E2 defines new equilibrium with price P2 and quantity Q2.
c) When government in beef producing countries ordered for mass slaughter of cows then this
reduce supply of beef. Additionally, the warnings given to consumers regarding harmful
effect of beef consumption reduces demand supply. As both demand and supply changes new
market equilibrium is obtained incorporating both the direction and magnitude of change in

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supply and demand (Mahanty 2014). Followings are the three cases for all possible
combination of demand and supply change.
Case i
When demand changes at a greater magnitude than supply then both price and
quantity of beef reduces at the new equilibrium.
Figure 5: Greater proportionate change in demand
(Source: as created by Author)
Case ii
When magnitude of supply change is greater than demand change then the supply
shortage pushes prices up and quantity reduces as before.

7ECONOMIC PRINCIPLES
Figure 6: Greater proportionate change in Supply
(Source: as created by Author)
Case iii
When supply and demand change by equal magnitude then there is no change in price
while quantity reduces under new equilibrium.
Figure 7: Equal changes in demand and supply
(Source: as created by Author)

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Answer 3
As the increase in supply new commercial apartment is accompanied with decline in
demand for such apartments there is a change in both demand and supply. Depending on the
magnitude of change three possible cases can be formed.
Case i
Suppose increased supply of new apartment exceeds that of decline in demand. As the
supply force dominates, there is a surplus of new apartments (Zinn et al. 2016). Under the
new equilibrium price declines while equilibrium number of apartments increases.
Figure 8: Larger change in Supply
(Source: as created by Author)
Case ii
Consider a case where demand declines at a greater proportion than increase in
supply. In this situation, both price and equilibrium number of apartments decreases.

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Figure 9: Larger change in Demand
(Source: as created by Author)
Case iii
An extreme situation is where demand and supply changes by the same magnitude.
Here price declines as usual leaving number of apartment unchanged in the new equilibrium.
Figure 10: Same change in demand and supply
(Source: as created by Author)

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Answer 4
a)
The price elasticity of demand using mid-point method is given as
Where,
P1: old price
P2: new price
Q1: old quantity
Q2: new quantity
Therefore, price elasticity of demand is computed as

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b) Price elasticity of demand captures the responsiveness of quantity demand for a
corresponding change in price. The elasticity value is -2.59. This implies 1 percent increase
in price causes a decrease quantity demanded by 2.59 percent. As demand changes at a
greater proportion than price change demand is relatively elastic in nature. With elastic
demand the business owner should never increase the price because it then decreases revenue
(Baumol and Blinder 2015). On the other hand, price reduction is profitable for the business
as it will then increase sales volume by a greater proportion.
Answer 5
The CEO of happy enterprise switches the business strategy from sales maximization
to profit maximization. Profit of a firm is obtained as revenue less income. The output choice
that leads to profit maximization can be made using two alternative approaches.
Profit maximization with Marginal Revenue –Marginal Cost method
This is the most commonly used method for maximizing profit. This approach
requires additional revenue from one additional unit should be equal to additional cost of
producing that unit. Under this method, the firm should compare marginal revenue and
marginal cost corresponding to every unit and choose that output level where marginal cost
equals marginal revenue (Pindyck and Rubinfeld 2015).

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Figure 11: Profit maximization using MR-MC method
(Source: as created by Author)
In figure 11, E is the profit maximizing equilibrium point. Firm can attain maximize
its profit by selling Q* output at price P*.
Profit maximization with Total Revenue –Total Cost method
Under this approach profit maximizing output is chosen from where the difference
between total revenue and total revenue is maximized. This corresponds to the point where
total revenue is maximum and total cost is minimum.

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Figure 12: Profit maximization using TR-TC method
(Source: as created by Author)
The vertical distance between total revenue curve and total cost curve measures the
profit. The distance is maximized at output level Q0 and hence give profit maximizing output.

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References
Baumol, W.J. and Blinder, A.S., 2015. Microeconomics: Principles and policy. Cengage
Learning.
Blad, M.C. and Keiding, H., 2014. Microeconomics: institutions, equilibrium and
optimality (Vol. 30). Elsevier.
Krugman, P., Wells, R., Au, I. and Parkinson, J., 2015. Microeconomics: Canadian Edition.
Macmillan Higher Education.
Mahanty, A.K., 2014. Intermediate microeconomics with applications. Academic Press.
Pindyck, R.S. and Rubinfeld, D.L., 2015. Microeconomics; Eight Edition, Global Edition.
Zinn, J., Arjomand, L., Finlay, N., Kheirandish, R. and Solomon, G., 2016. Principles of
Microeconomics.