Question

Bon Appétit is a French restaurant that recently increased the average price of its meals by 4%. As a result, the number of customers dropped by 3%. Based on this information, what is the price elasticity of demand for meals at Bon Appétit? How will this 4% increase of the average price of meals impact total revenue at Bon Appétit? (10 points) Another French restaurant in the area that competes with Bon Appétit decided to reduce the average price of its meals by 3%. How will this decision likely impact the demand for meals at Bon Appétit? (5 points) Assume that the average disposable income in the area in which operates increases by 5% over the last year. As a result, the number of customers at Bon Appétit increased by 3%. Based on this information, what is the income elasticity of demand for meals at Bon Appétit? Are meals at Bon Appétit considered normal goods? (10 points)

Answer 1

a)

Percent change in average price=+4%

Percent Change in quantity demanded=-3%

Price elasticity of demand=Percent Change in quantity demanded/Percent change in average price

Price elasticity of demand=-3%/4%=-0.75

Absolute price elasticity is less than 1, It means that demand is inelastic in this price range.

Since demand is inelastic, total revenue will increase as a result of price increase.

b)

Since competitor's meals are substitutes to Bon Appetit's meals, a reduction in substitute's prices will decrease the demand for meals at Bon Appetit as some of the consumers will switch over to another restaurant with reduced prices.

c)

Percent change in average disposable income=+5%

Percent change in demand=+3%

Income elasticity of demand at Bon Appetit =Percent change in demand/Percent change in average disposable income

Income elasticity of demand at Bon Appetit =3%/5%=0.60

Income elasticity for Bon Appetit meals is positive, it means that meals at Bon Appetit are normal good.