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For the first time in two years, Big G (the cereal division of General Mills) raised cereal prices by 4 percent
For the first time in two years, Big G (the cereal division of General Mills) raised cereal prices by 4 percent. If, as a result of this price increase, the volume of all cereal sold by Big G dropped by 5 percent, what can you infer about the own price elasticity of demand for Big G cereal? Can you predict whether revenue on sales of its Lucky Charms brand increased or decreased?
Expert Solution
Price elasticity = percentage change in quantity / percentage change in price = 5% / 4% = 1.25.
Total revenue will decline. In this case, the elasticity is bigger than 1, indicating that demand for Big G cereals is elastic. Raising prices will reduce revenue for the company because a one percent increase in price will lead to more than one percent drop in quantities sold. Recall that total revenue = price x quantity, the drop in quantity more than offsets the increase in price, so total revenue will decline.
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