Problem

Suppose you are the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of $20. On the basis of a survey, you have determined that reducing the price of an average meal to $18 would increase the quantity demanded to 450 per day.

1. Compute the price elasticity of demand between these two points.

2. Would you expect total revenues to rise or fall? Explain.

3. Suppose you have reduced the average price of a meal to $18 and are considering a further reduction to $16. Another survey shows that the quantity demanded of meals will increase from 450 to 500 per day. Compute the price elasticity of demand between these two points.

4. Would you expect total revenue to rise or fall as a result of this second price reduction? Explain.

5. Compute total revenue at the three meal prices. Do these totals confirm your answers in (b) and (d) above?