Case 4:

A famous brand of Italian luxury fashion and leather goods imports the belts at a cost of $6 (Assume
that the marginal cost is constant at $6). The company sales of leather belts in year 2018 was 12,000
units at a price of $24 each. The company did the market research and based on their analysis, the
relationship between the sales volume measured in thousands of units (Q) and price (P) is given by Q
= 60 – 2P. Use this information to answer the below questions:
a) Derive the equations of Total revenue, marginal revenue and the average revenue. Draw
TR, MR and AR on the same graph. Can you conclude from the graph as from what Q, the sale of
further units of leather belts will start to reduce the total revenue?
b) The company wishes to maximize the total revenues. Can you comment without doing any
calculations whether the price would need to be higher or lower than the profit-maximizing price?
Explain your answer (Make sure not to use any calculations/numbers to explain your answer)
c) What is the point elasticity of demand for the firm when price is $24 and number of leather
belts sold are 30,000? Is there any relationship between MR and price elasticity when MR = 0?
Explain as why the manager of the company needs the concept of price elasticity of demand while
making the decision.
Answer:
a) Q = 60 - 2P
Average revenue: AR = P = 30 - 0.5Q
Total Revenue: TR = P*Q = 30Q - 0.5Q2
dTR
Marginal Revenue: MR= =30−Q
dQ

500
400
AR, TR, MR

300
200
100
0
0 4 8 12 16 20 24 28 32 36 40 44 48 52 56 60
-100
Q

AR TR MR
When quantity Q exceeds 30, total revenue starts to decline.
b) Revenue is maximized when marginal revenue equals zero. On the other hand, profit is
maximized when marginal revenue equals marginal cost. From the graph, we can see that
marginal revenue and quantity has a negative linear relationship, thus the quantity at which
marginal revenue equals marginal cost (profit is maximized) is smaller than the quantity at
which marginal revenue equals zero (revenue is maximized). Moreover, price and quantity
 has a negative linear relationship, so the price at which profit is maximized would be higher
than the quantity at which revenue is maximized
dQ
∗P
c) Elasticity of demand = dP −2∗24
= =−1.6
Q 30
The absolute value of elasticity is higher than 1, meaning demand is elastic.

When MR=0=30 – Q ↔ Q=30 ↔ P = 30 - 0.5*30 = 15

dQ P 15
Elasticity of demand = x =−2 x =−1
dP Q 30
The absolute value of elasticity is 1, meaning demand is unit elastic.
When absolute value of elasticity is higher than 1, demand is elastic, revenue will decrease
when price is increased. When absolute value of elasticity is lower than 1, demand is elastic
and revenue will decrease when price is increased. This is a very important information for
managers to make decision regarding pricing their products to maximize revenue.