Discussion Topic

# Impact of Price Reduction on Total Revenue and Price Elasticity of Demand for a Restaurant

Summary:

Reducing prices can impact a restaurant's total revenue depending on the price elasticity of demand. If demand is elastic, a price reduction will likely increase total revenue as more customers are attracted by lower prices. Conversely, if demand is inelastic, total revenue may decrease because the increase in quantity demanded won't be sufficient to offset the lower prices.

Suppose you are the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of \$20. On the basis of a survey, you have determined that reducing the price of an average meal to \$18 would increase the quantity demanded to 450 per day. Would you expect total revenue to rise or fall as a result of this second price reduction? Compute total revenue at these prices.

As the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of \$20, you are interested in ways of boosting total revenue. If the results of a survey have determined that reducing the price of an average meal to \$18 would increase the quantity demanded to 450 per day, then this is an initiative you should take.

If the survey is correct, then the reduced price of \$18 per meal would be expected to yield total revenue of \$8,100 (450 x \$18 = \$8,100). By comparison, at the \$20 average price per meal, the restaurant generated total revenue of \$8,000 (400 x \$20 = \$8,000). The \$2.00 or 10.0% drop in the price of an average meal will be more than offset by a 12.5% increase in quantity demanded to produce a 1.3% improvement in total revenue.

This is just straight math, but there is more to it than just the change in quantity demanded. The other question you need to determine is what happens to demand for additional items at the \$18 price point compared to \$20? Do patrons feel more inclined to order dessert if they pay 10% less for their main meal? Do they feel more inclined to order a beverage at the lower price point? There is a subtle benefit of pricing the meal at \$18 versus \$20. That is the reason that so many products are priced at \$9.99 rather than \$10.00. If a certain percentage of patrons order additional items now, then the benefit of lowering the price of an average meal could be higher than the 1.3% gain in total revenue that is based solely on quantity x price.

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Suppose you are the manager of a restaurant that serves an average of 400 meals per day at an average price per meal of \$20. On the basis of a survey, you have determined that reducing the price of an average meal to \$18 would increase the quantity demanded to 450 per day. Compute the price elasticity of demand between these two points. Would you expect total revenues to rise or fall?

The change in demand of most goods is inversely proportional to the change in price. If the price of the good increases, there is a fall in demand, and demand increases when the price is decreased. The price elasticity of demand is equal to the ratio of percentage change in demand and the percentage change in price.

The restaurant is able to sell 400 meals per day at an average price of \$20. A survey conducted by the manager of the restaurant has conducted a survey that indicates Based on a survey conducted by the manager of the restaurant, the number of meals sold would increase to 450 if the price is decreased to \$18. The percentage increase of demand is (450-400)/400 = 0.125 if the percentage decrease of price is (20-18)/20 = 0.1. The elasticity of demand in this case is 0.125/0.1 = 1.25.

The revenue of the restaurant when the meals are sold at \$20 is 400*20 = \$8000. If the price is decreased to \$18, the number of meals sold increases to 450, this gives a revenue of 18*450 = \$8100.

The revenue of the restaurant would increase if the restaurant's manager follows the findings of the survey and decreases the average price of the meal.