Stable and predictable prices seem to be valued by retail customers, especially for items that enjoy a high degree of repeat sales. So when a company like Wal-Mart decides that it has to raise the price on its ice cream, for example, it has two choices: (a) increase the price it charges for each unit of ice cream or (b) leave the price per unit unchanged, but shrink the size of the unit. Specifically, it could increase the price of a half-gallon (64 ounces) of ice cream by 10% from $4.00 to $4 40 or it could shrink the size of the carton of ice cream from 64 ounces to 58.2 ounces and leave the price per carton at $4.00—which also increases the price per ounce of ice cream by 10%. Suppose that before the price change, Wal-Mart was selling 1000 cartons of ice cream per week, and they increase the price by shrinking the carton size as described above.
a. Show that Wal-Mart will sell more than 1000 of the smaller cartons of ice cream if the price elasticity of demand for ice cream is “inelastic” but will sell less than 1000 of the smaller cartons if the price elasticity of demand for ice cream is “elastic.”
b. Knowing what you know about markets and demand elasticities, which to you think is most likely to actually occur: (a) Wal-Mart will sell more than 1000 of the smaller cartons of ice cream; (b) Wal-Mart will sell exactly 1000 of the smaller cartons of ice cream; (c) Wal-Mart will sell less than 1000 of the smaller cartons of ice cream. Explain why you KNOW the answer to this question using the analysis from this class. (That is, I want solid, analytically-based answers, not just some ad hoc intuition that you have.)