Question

The owner of a small chain of gasoline stations in a large Midwestern town read an article in a trade publication stating that the own-price elasticity of demand for gasoline in the United States is –0.2. Because of this highly inelastic demand in the United States, he is thinking about raising prices to increase revenues and profits. Do you recommend this strategy based on the information he has obtained?

Answer 1

Based on the information he has obtained I not recommend this strategy, because the elasticity of demand for his gas stations is likely much higher (in absolute value) than -0.2.

Explanation:

The owner of a small chain of gasoline stations in a large Midwestern town read an article in a trade publication stating that the own-price elasticity of demand for gasoline in the United States is –0.2. Because of this highly inelastic demand in the United States, he is thinking about raising prices to increase revenues and profits.

Price elasticity of demand is the measure to show the responsiveness of the quantity demanded of a good or service to increase in its price when nothing but the price changes. Gasoline is a relatively inelastic product, meaning changes in prices have little influence on demand. You need gasoline, and therefore the demand for it is relatively inelastic

Do you recommend this strategy based on the information he has obtained?

• a.) Yes - since his elasticity is -0.2, a price increase will raise revenues.
• b.) Yes - the elasticity of demand for his gas stations is likely lower (in absolute value) than -0.2.
• c.) No - since his elasticity is -0.2, a price increase will lower revenues.
• d.) No - the elasticity of demand for his gas stations is likely much higher (in absolute value) than -0.2.

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Answer 2

Answer:

No, the owner should not increase price.

Explanation:

The own-price elasticity of demand for gasoline in the US is -0.2. The reason behind this inelastic demand is that gasoline does not has close substitutes and it is a necessary good.

The owner of the gas station is confusing the own-price elasticity of demand in the US for own-price elasticity of demand for his station. The owner is operating in a large town.

In a large town, there is a large number of gas stations nearby, so the demand for gasoline in the same town is generally elastic. If the owner increases the price, the consumers will purchase from other gas stations. This will cause the demand for the owner's station to decrease. This will further decrease his revenue and profits.