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Interpret and successfully apply economic concepts of supply and demand for effective organisational problem solving.

Projection on income, inflation, and tariff development

Marketing planning of a business is subject to economic environment of the targeted market. Schmeckt Gut recently plans to launch Schmeckt Besser energy bar in the Atolia market within the few upcoming months. In order to make a smooth entry in the market, market analysis has been conducted by the department of research. The objective is to analyze economic and market condition in Atolia so that suitable strategy can be designed (Burns & Dewhurst, 2016). A complete report is prepared using the market analysis data of Schmeckt Gut’s energy bar. The market analysis report contains quarterly data on demand, income, inflation, tariff and number of gyms.

The variables that are particular interest of the report are demand, income, inflation and tariff. Different combination of income, inflation and tariff have different impact economic variables. In order to match different projection of income, inflation and tariff, the projected effects are discussed with the theories of demand, supply, aggregate demand, aggregate supply, Phillips curve and Laffer curve. After matching different projection, the report offers a demand estimation for energy bars in the region. Factors whose impact on demand are analyzed particularly include income, inflation and tariff. An increase in income is generally expected to increase demand of energy bars (Mariotti, S., & Glackin, 2014). Inflation by raising average price level tends to reduce energy bar demand. Like inflation tariff might have an adverse effect on demand. The proposed relationship is estimated using multiple linear regression. Based upon the market analysis and demand estimation some strategies are recommended to help the company to enter the Atolia market.

Income, inflation and tariff are the three crucial macroeconomics variables. A change in income has a direct effect on demand. Change in income along with an associated change in inflation affects the real income of people. The change in real income in turn depends on the magnitude of change in income and inflation. If income rise more than inflation, then people experiences an increase in real income which is beneficial for economic expansion. In the opposite case where inflation rises more than income then people suffers from a loss in real income (Varian, 2014). The condition of trade is another influencing factor for state of the economy. Under free trade condition both the participating nations benefits. As a country attempts to restrict trade by imposition of tariff it affects buyers and sellers of both the nations. Therefore, various combination of tariff rate has various effect in the economy. The projected income of a change in income, inflation and tariff is discussed using the framework of traditional economic theories.

Supply and demand

Two dominants forces of a free market are the market demand and market supply. People’s desire of a good subject to the purchasing ability is represented with the market demand curve. Market supply curve on the other hand represents producers’ preferences for supplying a particular good at a given market price. These two forces work together to determine efficient allocation of resources in a market. Market equilibrium is determined from the common interest of both parties (buyers and sellers). A change in demand or supply causes due to change in any other factors except own price of the good shift the demand or supply curve (Cowell, 2018). This actually causes equilibrium position to change in the market. 

The market data of Atolia reveals an increasing trend in income. The increased income brings an increasing desire for people towards a healthy lifestyle. For this, they might consider to join a gym and substitute their regular diets with supplementary products such as energy bars. This offers Schmeckt Gut an ideal market to launch Besser energy bars. As demand increases followed by an increase in income there is an upward pressure on price. Increase is income thus has a possible impact on inflation. The increased price increases profit of sellers given the fact that cost remains same. If Industria allows a free trade, then increased income attracts foreign firms to enter the market which can hurt the domestic suppliers. Realizing this fact government attempts to restricts trade through imposing or revising the tariff rate. This shows how an income development is associated with a projected increase in inflation and rate of tariff.

For a single market efficient allocation of resources is determined from market demand and market supply curve. Consideration of aggregate demand and aggregate supply is necessary for the determination state of equilibrium for the whole economy. The overall demand or expenditure in an economy is represented by the aggregate demand. The aggregate demand include expenditure from four major areas namely consumption, investment, expenditure by government and net export. Like market supply, aggregate supply is determined from availability of goods and services in the economy (Rao, 2016). The macroeconomic equilibrium as determined from joint forces of aggregate demand and aggregate supply determines the equilibrium level of aggregate output and price level. 

Change in aggregate demand or aggregate supply causes a change in national income and price level or inflation. Consider the effect of a growth in income. Income growth generally causes a growth in aggregate demand. In response to a higher aggregate demand, the aggregate demand curve shifts to the right. With shift in the aggregate demand a new equilibrium is obtained at a higher level of aggregate output and price. This form of inflation caused from an increase in aggregate demand is termed as demand pull inflation (Michaillat & Saez, 2015). The economic expansion in terms of higher output and inflation encourages foreign suppliers to the market. With increase in import demand and flow of imported items in the market a policy of trade restriction might be placed in forms of higher tariff. The lower import further increases aggregate demand. The final effect on aggregate demand depend upon the change in income, inflation and tariff. For example, a 3% increase in income, 2% increase inflation causes 1% increase in real income. This when combines with a 7.5% increase in tariff reduces import and increases aggregate demand. In contrast a 1% increase in income in combination of 2% increase in inflation leads to a 1% decline in real income. This with 0% tariff rate reduces aggregate demand. The effect on aggregate demand thus varies with different combination of changes in income, inflation and tariff.

Aggregate demand and aggregate supply

Professor A. W. Phillips in the nineteenth century examined how unemployment rate is related with that of inflation rate. Rate of inflation and unemployment in the economy generally move in the opposite direction. The inverse relationship can be explained in both ways. Firstly, when inflation increases, business enjoys a higher profit. This contributes to business expansion leading to a rise in labor and hence a reduction a decline in unemployment. Conversely, low unemployment implies a low level of unemployment indicates higher demand for labor (Bernanke, Antonovics & Frank, 2015). In the factor market high labor demand pushes up wages and cost. Rise in wage cost is reflected in form a high inflation. 

Given different projection on inflation in Atolia market, unemployment tends to change. A rise inflation thus can lead to a decline unemployment. When unemployment reduces, income likely to be increased. Varying combination of inflation is associated with varying level of employment and income.

Economist Arthur Laffer developed the concept of Laffer curve. The curve shows how tax revenue changes in relation to proposed tax rate (Badel & Huggett, 2017). The theory states that at a relatively low level of tax, collected revenue increases from an increase in taxation. Tax revenue however increases only up to a certain point. Beyond that point further increase in tax has no added benefit on tax revenue. In fact, revenue falls to 0 corresponding to a 100 percent tax rate.  The same theory is applicable while deciding tariff rate (Mavroeidis, Plagborg-Moller & Stock, 2014). From the Atolia market data it is seen that tariff revenue first increase from 5% to 10% but then it falls to 7.5%. This can be explained with Laffer’s proposition that beyond 10 percent tariff rate, tariff revenue might fall and that is why government reduces the tariff rate to 7.5 percent. 

Figure 4: Laffer curve

(Canto, Joines & Laffer, 2014)

The demand of energy bars likely to vary with a projected change in income, inflation and tariff rate. Number of gym might also influence the demand for energy bars and hence, is also considered in the market analysis of Schmeckt Gut. Multiple linear regression is used to evaluate the impact income, inflation and tariff rate potential demand of energy bars. The multiple regression model is an appropriate tool for estimating relationship between demand and the expected determinant factors (Draper & Smith, 2014). In the built regression model, the dependent variable is demand. Two independent variables are considered for predicting demand namely inflation and tariff. The demand equation for energy bars is given as 

Phllips curve

α: intercept of the equation

β: regression coefficient for income

γ: regression coefficient for tariff

δ:  regression coefficient for inflation

The regression result as obtained using the data of market analysis is summarized below

Regression Statistics

Multiple R

0.92

R Square

0.85

Adjusted R Square

0.83

Standard Error

23.22

Observations

20

ANOVA

df

SS

MS

F

Significance F

Regression

3

50864.70502

16954.9017

31.435422

6.10544E-07

Residual

16

8629.705371

539.356586

Total

19

59494.4104

Coefficients

Standard Error

t Stat

P-value

Lower 95%

Upper 95%

Intercept

82.954

31.396

2.642

0.018

16.397

149.512

Income

0.018

0.002

9.303

0.000

0.014

0.022

Tariff

-12.049

2.926

-4.117

0.001

-18.252

-5.845

Inflation

-14.287

7.603

-1.879

0.079

-30.404

1.830

The estimated demand equation for energy bar is obtained as 

The goodness of fitted model depends on the value of R square. This estimated value of R square gives explanatory power of a regression model. The obtained value of R square is 0.92. The R square value close to 1 means that the model is a good fit model. In context of the demand model, the R square value implies that income, inflation and tariff together responsible for 92 percent variation in the demand for energy bar (Chatterjee & Hadi, 2015). As most of the variations in demand are explained by the chosen three variable, inflation, income and tariff can be considered as significant determining factor energy bar demand. The ANOVA table gives a significant value of F statistics supporting the overall significance of the model.

The first determinant factor of energy bar demand is income. For any normal good, the demand theory predicts a positive relation between demand and income. The coefficient of income is positive having a value of 0.018.  The obtained positive coefficient thus supports the standard norms of demand. An increase in demand thus increase demand for energy bars and vice versa. This is because, when people experience an increase in their income their affordability of energy bar increases. Given energy bars are healthy energy supplement, demand for energy bars increases P value corresponding to income is obtained as 0.000, which is lower than the significance level of 0.05. The significant p value means rejection of null hypothesis proposing no significant relation between income and demand. Income is therefore a positive significant determinant of demand.

Tarff is a form of tax. A tariff on import from Industria advances the price of energy bar in the domestic market of Atolia. The increased price of energy bar from Industria thus likely to reduce the demand for energy bars in the Industria market. This is further confirmed from the regression result which gives a negative coefficient for tariff. The associated coefficient of tariff is – 12.049. Increase in tariff thus has an adverse effect on energy bar’s demand. p value for the coefficient is 0.001. The significant p value implies that tariff rate is a negative significant determinant of energy bar in the Atolia market.

Laffer curve

Inflation is an indicating measure of price level. Higher the price level lower is the real income and lower in the demand. The coefficient corresponding to inflation is -14.287. This shows as inflation rises there is a decline in demand for energy bars. This is because as price level increase, cost of basket for maintaining a certain standard of living increases as well. People then try to cut down consumption and focuses on consumption of only necessary goods. Now, energy bar is not a necessary good rather it is associated with an improved living standard. People therefore has a tendency to reduce the demand for energy bar. In the estimated model, p value for inflation is obtained as 0.079, which is higher than the significance level. This indicates inflation is not a statistically significant determinant of demand (Darlington & Hayes, 2016).

The above discussed demand model shows influence of income, rate of inflation and tariff rate on energy bar demand in the Atolia market.  Income is a positive determinant of demand while inflation and tariff rate inversely influences demand. Therefore, different projection of income, tariff rate and inflation rate having different effect of income. In case change in income is higher than that of inflation and tariff demand would increases. In cases where inflation and change in tariff rate dominates that of the income change demand would fall. Inflation in addition to its direct impact on demand for energy bars also has an indirect channel of influencing demand. The alternative channel is its impact on real income which is the nominal income after discounted by the inflation rate. Therefore, if inflation rises more than income, then real income falls and so is the energy bar demand. For situation where income increase more than inflation real income increases leading to an increase in energy bar demand. The ultimate effect of a simultaneous change thus depends on magnitude of change in the three demand determining factor.

Conclusion and Recommendation 

The different projections of income, inflation and tariff rate are attempted to be matched with each other with the help of different theories. The analysis reveals that a 5% increase in income is associated with a corresponding increase in aggregate demand. The rise in income in turn raise price level in the economy. If inflation increases by 2% then real income increases by 3%. When demand increases and foreign producers enter the market competition increases. This might encourage government to impose a tariff on import from Industria to restrict import competition. Different projection of income, tariff and inflation thus have a differential impact on economic variables. Demand of Schmeckt Gut’s energy bar is estimated taking income, inflation and tariff as determinant factors. In Atolia, increase in income has a positive influence on demand for energy bars. The other two factors that is inflation and tariff rate have detrimental effect on energy bar demand. The market analysis thus provides useful insight to the company and help Schmeckt Gut to successfully launch its energy bar in the Atolia market.

The data from market survey in Atolia shows that there is continuous increase in income. Both the theory and regression analysis suggest that rising income pulls up the energy bar demand. This in turn shows a profitable market of energy bar in Atolai and hence, the company can smoothly enter the market. However, before entering the market it should design a suitable marketing strategy. In order to attract more demand, it should make good promotion of Besser energy bars. The company should take care of the fact that an appropriate marketing strategy is needed to effectively compete with existing domestic producers. Investment in advertise or brand promotion is highly recommended for the company at this stage.

Demand of energy bars is negatively affected from rising inflation. The company therefore should enter the market in times where price level remains relatively stable in Atolia.  With a rising trend in price level people tend to reduce demand for energy bars and hence, entering the new market would not be beneficial The company initially can offer some price discount to increase in customer base. Another factor detrimental to demand is the tariff rate. Free trade or lower tariff means a relatively lower price of imported energy bar in Atolia. This attracts people in Atolia to purchase Schmeckt Gut’s energy bar. Therefore, the company should negotiate with the trade minister to promote free trade between the two nations. The trade minister of Industria needs to be convinced to lower the tariff rate.  The company thus needs to consider all the possible factor that influence energy bar demand then design the suitable strategy for entering the Atolia market with Besser energy bar. 

Reference list 

Badel, A., & Huggett, M. (2017). The sufficient statistic approach: Predicting the top of the Laffer curve. Journal of Monetary Economics, 87, 1-12.

Bernanke, B., Antonovics, K., & Frank, R. (2015). Principles of macroeconomics. McGraw-Hill Higher Education.

Burns, P., & Dewhurst, J. (Eds.). (2016). Small business and entrepreneurship. Macmillan International Higher Education.

Canto, V. A., Joines, D. H., & Laffer, A. B. (2014). Foundations of supply-side economics: Theory and evidence. Academic Press.

Chan, J. C., Koop, G., & Potter, S. M. (2016). A bounded model of time variation in trend inflation, NAIRU and the Phillips curve. Journal of Applied Econometrics, 31(3), 551-565.

Chatterjee, S., & Hadi, A. S. (2015). Regression analysis by example. John Wiley & Sons.

Cowell, F. (2018). Microeconomics: principles and analysis. Oxford University Press.

Darlington, R. B., & Hayes, A. F. (2016). Regression analysis and linear models: Concepts, applications, and implementation. Guilford Publications.

Draper, N. R., & Smith, H. (2014). Applied regression analysis(Vol. 326). John Wiley & Sons.

Mariotti, S., & Glackin, C. (2014). Entrepreneurship and small business management. Pearson Higher Ed.

Mavroeidis, S., Plagborg-Moller, M., & Stock, J. H. (2014). Empirical evidence on inflation expectations in the New Keynesian Phillips Curve. Journal of Economic Literature, 52(1), 124-88.

Michaillat, P., & Saez, E. (2015). Aggregate demand, idle time, and unemployment. The Quarterly Journal of Economics, 130(2), 507-569.

Rao, B. B. (Ed.). (2016). Aggregate demand and supply: a critique of orthodox macroeconomic modelling. Springer.

Varian, H. R. (2014). Intermediate Microeconomics: A Modern Approach: Ninth International Student Edition. WW Norton & Company.

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