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?
So a large part of your task is to determine how New York and Chicago are different for this purpose. You know the following:
• In New York, your client has 8 – 10 closely competing restaurants (similar menus, pricing structures, clientele); in Chicago, the client will have about 3 direct competitors.
• Your client believes its “target market” consists of households earning $150,000 or more per year in New York and $100,000 or more in Chicago.
see my response to Tiffany above.
To determine what the client thinks the price elasticity of demand is in New York, we can use the information provided about the client's pricing and marginal cost.
Given that the client's New York strip steak dinner sells for $45 and the marginal cost is estimated to be $27, we can use the equation MC = (1 - 1/åp) * P to solve for the client's perceived price elasticity of demand (åp).
Rearranging the equation, we get:
åp = (1 - MC/P)
Plugging in the values for MC ($27) and P ($45) for the New York restaurants, we can calculate the client's perceived price elasticity of demand in New York:
åp = (1 - 27/45)
åp ≈ 0.4
So the client believes that the price elasticity of demand for the New York strip steak dinner in New York is approximately 0.4.
Now, if we recommend a higher (lower) price in Chicago, it would mean that we have concluded that demand is more price elastic (less price elastic) than in New York.
To determine how New York and Chicago are different in terms of demand elasticity, we need to consider the provided information:
1. Competition: In New York, the client has 8-10 closely competing restaurants with similar menus, pricing structures, and clientele. In Chicago, the client will have about 3 direct competitors. This suggests that the level of competition may be different between the two cities.
2. Target market: The client believes its "target market" consists of households earning $150,000 or more per year in New York and $100,000 or more in Chicago. This implies that the income levels of the target market may differ between the two cities.
Based on this information, we can make an inference:
Given that there are fewer direct competitors in Chicago and a lower income threshold for the target market compared to New York, it is likely that the demand for the New York strip steak dinner in Chicago would be more price elastic.
Therefore, if we recommend a higher price in Chicago, we have concluded that demand is more price elastic in Chicago compared to New York.