Situation : Three Guys Named Moe, a moving company in Econopolis, is contemplati
ID: 1191054 • Letter: S
Question
Situation: Three Guys Named Moe, a moving company in Econopolis, is contemplating a price hike. Right now, they charge $20 per hour, but Moe #1 thinks they could get $30. Moe #2 disagrees, saying it will hurt the business. Moe #3, the brains of the outfit, has calculated the price elasticity of demand for their moving services in the range from $20 to $30 and found it to be 0.5. What will be the impact of a price increase on the company’s Total Revenue?
Should they do as Moe#1 suggests and raise the price? Why or why not?
Currently, Three Guys is the only moving company in Econopolis. Moe reads in the paper that several new movers are planning to set up shop there within the next year. After these competing firms move into Econopolis, is the demand for Three Guys’ services likely to be more elastic, less elastic, or the same? Why?
Explanation / Answer
Price elasticity = 0.50.
Since absolute value of price elasticity is less than 1, demand is inelastic. So, an increase in price will not decrease quantity demanded to a proportionate extent and therefore, total revenue will increase as price is increased.
If price is increased from $20 to $30, Change in price = $(30 - 20) / $20 x 100 = 50%
So, quantity demanded will decrease by (0.5 x 50%) = 25%.
If Q be original quantity demanded, original revenue = $20 x Q
Revised revenue (after price increase) = $30 x 0.75Q = $22.5Q
So, Total revenue has increased.
Currently, Three Guys is the sole moving company, therefore is a monopolist. Since there is no substitute service as of now, demand is highly inelastic as buyers cannot switch to other substitutes even if price is raised.
But in presence of competition, demand will become more elastic since as a response to a price increase, buyers can switch from Three Guys to other competitors.