A large multinational restaurant chain has introduced gourmet burgers in addition to the fast-food style hamburgers it has always sold. We consider here the actions of a single franchise’s store and its pricing policy.
The franchise manager estimates that daily demand for gourmet burgers is represented by
Q = 145.67 – 5.85P where:
P = price per gourmet burgers in dollars
Q = number of gourmet burgers sold per day.
Current average daily sales of gourmet burgers are 60.
a) What price is the cafe currently charging for gourmet burgers?
b) Since the introduction of the customising option, the local franchise has noticed that average daily sales of gourmet burgers increased from 56 to 60 and average daily sales of traditional fast-food burgers increased from 83 to 85. Over the same period, consumers’ incomes have risen by 6%. Specify and calculate the elasticities that the local franchise can use to explain the changes in sales. State any assumption you are making. State whether gourmet burgers and traditional fast-food hamburgers are a normal, inferior or luxury goods. Explain your answers.
c) A competitor offers a similar gourmet burger at a price of $12.50. The restaurant chain is contemplating whether to match the price. Would the franchise lose revenue on gourmet burgers sales if it charged $12.50? Justify your conclusion based upon your estimate of the own-price elasticity of demand. State any assumptions you are making. Interpret the value and meaning of this elasticity (use the mid-point method to calculate the own-price elasticity of demand).
d) The chain estimates that daily sales of fast-food hamburgers would decline by 21.22% if the price of gourmet burgers was reduced to $12.50. Specify and calculate the elasticity that can be used to explain this relationship between the price of gourmet burgers and sales of fast-food hamburgers. State any assumptions you are making. Interpret the value and meaning of this elasticity (use the mid-point method to calculate the elasticity).
e) Using the information from parts a), b), c) and d) of this question, provide a recommendation as to whether the cafe should reduce the price of a gourmet burger to $12.50 to increase total revenue. Use a price for hamburgers of $7.00 each and assume the supply of hamburgers is perfectly price elastic. State any other assumptions you make.