posted by Tiffany on .
You are a team working for an economic consulting firm; your client is “The New Delmonico Steakhouse,” a high-end steak place with four restaurants in Manhattan. Your client is considering opening a single restaurant in Chicago (in the Loop), and wants assistance in making a pricing decision on its “centerpiece” menu item, the 16-ounce New York strip steak. At its New York restaurants, this item sells for $45, and comes with a house salad and the diner’s choice of a baked potato or roasted asparagus. Your client’s estimate of the marginal cost of preparing and serving the meal is about $27; they expect a similar marginal cost at a restaurant in Chicago. Your task is to determine whether the most profitable price in Chicago would be higher, lower, or the same as in New York. (Remember that the rule for selecting the profit-maximizing output is to pick the output at which MR = MC, and that MR = (1 – 1/åp)*P, where åp is the price elasticity of demand. (By substitution, therefore, you know that you want to price so that
MC = (1 – 1/åp)*P;
since you know both P and MC for the New York restaurants, you can determine what the client thinks the price elasticity of demand for the New York strip steak dinner is in New York.)
1. What does the client think the price elasticity of demand is in New York? If you recommend a higher (lower) price in Chicago, have you concluded that demand is more price elastic, or less price elastic than in New York?
use algebra and plug in known values.
You have MC=MR=(1-1/e)*P where Mc=MR=27 and P=45. Solve:
27/45 = (1-1/e)
-.4 = -1/e
e = 2.5 -- elastic
If P were higher, then e would have to be lower (more inelastic)
so would it not be advisable to raise the cost of the dinner in Chicago, even though they have less competitors? According to the problem, Chicago has 5 less competitors but less income per household and less households. How would that figure in?