1. Old Navy sell sports shirts for men; during 2016, Old Navy sold an average of 23,000 sports shirts for an average price of $26 per shirt in its Hulen Mall store in Fort Worth, Texas. In early January 2017, Gap a major competitor cut the price of its sports shirts from $30 to $24. The orders that Old Navy received for its own sports shirts dropped sharply, from 23,000 per month to 13,000 per month because of this action.
a. Calculate the cross elasticity of demand between Old Navy's sports shirts and Gap's sports shirts during February and March. Are the two companies' sports shirts good or poor substitutes? Why? Explain.
b. Suppose that the coefficient of price elasticity of demand for Old Navy's sports shirts is -2.0 Assuming that Gap keeps its price at $24, by how much must Old Navy cut its price to build its sales of shirts back up to 23,000 per month? (Hint: Use the arc formula for price elasticity and substitute the known values into it and solve for the unknown price).
c. Would you recommend that Old Navy cut its price to the value calculated in part (b)? Why or why not?