Reference no: EM13209968

A group of five students has decided to form a company to publish a guide to eating establishments located in the vicinity of all major college and university campuses in Texas. In planning for an initial publication of 6,000 copies, they estimated the cost of producing this book as follows:

Paper $12,000
Research 2,000
Graphics 5,000
Reproduction services 8,000
Miscellaneous 5,000
Personal computer 2,000
Desktop publishing software 500
Overhead 5,500
Binding 3,000
Shipping 2,000

By engaging in the business, the students realized that they would have to give up their summer jobs. Each student made an average of $4,000 per summer. However, they believed they could keep expenses down by doing much of the research for the book by themselves with no immediate compensation.
They decided to set the retail price of the book at $12.50 per copy. Allowing for the 20 percent discount that retail stores in the state generally required, the students anticipated a per-unit revenue of about $10.00. The director of the campus bookstore advised them that their retail price was too high, and that a price of $8.75 would be more reasonable for a publication of this kind.
One of the students, an economics major, asked the bookstore manager to provide her with historical data on sales and prices of similar books. From these data she estimated the demand for books of this kind to be

Q = 18,500 - 1,000 P
where Q = number of books sold per year
P = retail price of the books.

a. Construct a numerical table for the retail demand curve, and plot the numbers on a graph. Calculate the elasticity of demand for the interval between $12.50 and $8.00.

b. Do you think the students should follow the store manager s advice and price their book at $8.75? Explain. If you do not agree with this price, what would be the optimal price of the book? Explain.

c. Assuming the students decide to charge the optimal price, do you think they should proceed with this venture? Explain.

d. Assuming the student s demand equation is accurate; offer some possible reasons why the bookstore manager would want to sell the book at the lower price of $8.75.

E. Explain the impact on the optimal price of designating the "miscellaneous" cost item as fixed versus variable. (Hint: Do the pricing analysis assuming miscellaneous is a fixed cost and compare it with an analysis that assumes it is a variable cost.

F. Under what circumstances do you think the average variable cost would increase? Do you think the law of diminishing returns would play a role in increasing AVC? Explain.

G. Under what circumstances do you think the AVC would decrease? Explain.