AS Micro-Economics Homework Help Watch

RahRah20
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Hi. Finding this question difficult, help would be greatly appreciated!

A mobile phone company has 2 million customers for a package of services. Each customer pays a monthly fee of £25. The company conducts market research and estimates that price elasticity of demand for this package is -2.

If the company reduces monthly fees by £5, the change in total revenue is likely to be:

A). +£6 million
B). -£3 million
C). -£6 million
D). +£3 million

Answer and Explanation required for 4 marks. Thank you in advance!


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Mike_123
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(Original post by RahRah20)
Hi. Finding this question difficult, help would be greatly appreciated!

A mobile phone company has 2 million customers for a package of services. Each customer pays a monthly fee of £25. The company conducts market research and estimates that price elasticity of demand for this package is -2.

If the company reduces monthly fees by £5, the change in total revenue is likely to be:

A). +£6 million
B). -£3 million
C). -£6 million
D). +£3 million

Answer and Explanation required for 4 marks. Thank you in advance!


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Answer: A

Explanation:

P1 = £25
P2 = £20

%change in price is (20-25)/25 * 100 = -20%

Q1 = 2m
Q2 = unknown

... but we know the PED value and can rearrange its formula:

PED = %change in QD/%change in P

we know two of these components - PED and %change in P

so if we rearrange, we get

PED*%change in P = %change in QD

therefore %change in QD is -20%*-2 = +40%

--

Now that we have established that reducing the price by £5 will result in a 40% increase in sales, Q2 can be calculated at 2m*1.4 = 2.8m

To calculate total revenue (TR), we use TR = P*Q

so TR1 = P1*Q1 = 5m
TR2 = P2*Q2 = 5.6m

Therefore there is an increase in revenues of 0.6m.
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RahRah20
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Thank you so much! A very clear and detailed explanation. Thanks again!


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