1. Compute the elasticities for each independent variable. Note: Write down all of your calculations.
2. Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies. Provide a rationale in which you cite your results.
3. Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.
Answers:
The regression equation of demand for widgets is given as:
Where,
QD = Quantity demanded for 3-pack units
P (in cent) = Price of the product; Given P= 500 cent for 3 pack units
Px (in cent) =Price of leading competitor’s product; Given Px = 600 per 3 packs unit
Y(in dollars)= Per capita income of the standard metropolitan statistical areas located around the supermarkets; Given Y= $ 5,500
A (in dollars) = Monthly advertising expenditure; given A=$10,000
M= Number of microwave ovens sold in SMSA, where the supermarket located; given M= 5,000
Now, the demand for low calorie frozen microwave food is estimated as:
= 17650
Implication of measured elasticity
Here the computed value of price elasticity is -1.19. Since the value is greater than one it implies the demand for frozen microwave food is elastic in nature (Baumol & Blinder, 2015). The negative sign is because of the existence of inverse relation between price and quantity. Relatively elastic demand implies even a slight increase in price leads to a much higher contraction of demand. Thus, if the firm employs the policy of price rise then demand will reduced so much that revenue falls. On the other hand, the policy of price reduction will prove beneficial for the concerned firm. In response to a reduced price consumers will increase their demand to great extent which will help to expand its sales and hence revenue.
The elasticity with respect to competitor’s product is 0.68. This is supported with economic theories of cross price elasticity (Wang, 2016).The cross price elasticity in case of substitute product is always positive. The magnitude of elasticity is 0.68. This implies a rise in the price of the competitor’s product has a positive impact on the demand of the firm’s product. However, the effect is less as compared to the effect of own price change.
The income elasticity is positive and having a value of 1.62. This means demand is highly responsive to the change in income of the local metropolitans. When income rises then these people increase their spending on frozen food.
Elasticity in response to advertising expense is positive but inelastic. Magnitude of elasticity is 0.11.This means when advertise expenditure changes then quantity demanded changes to a smaller proportion as compared to change in expense. Thus, to make a considerable change in sales the firm should spend a large amount on advertising.
Finally, the elasticity in reference to number of microwave sold is very low. The measured elasticity is 0.07. This indicates inelasticity of demand with respect to microwave sold in the area.
Recommendation
The firm should cut its price to capture a greater market share. From the demand equation the estimated own price elasticity of demand is elastic and significant. Demand changes by a greater proportion with a change in price. Thus, if the firm adapts the policy of price cut then consumers increase their demand by a greater percentage. This will help the firm to increase its sales and hence profit by capturing a greater market share.
Demand curve, supply Curve and Equilibrium
If the demand affecting other factors except prices remains same then the demand equation looks as follows:
Putting the values of Price as 100,200, 300,400, 500,600 cents the corresponding demand are estimated.
The Supply equation is given as follows:
Putting the values of P as 100, 200,300,400,500,600 the quantity supplied are estimated.
The values of quantity demanded and quantity Supplied are represented in the following table:
|
Price (P)
|
Quantity Demanded (QD)
|
Quantity Supplied (QS)
|
|
100
|
34450
|
0.00
|
|
200
|
30250
|
7909.88
|
|
300
|
26050
|
15819.80
|
|
400
|
21850
|
23729.70
|
|
500
|
17650
|
31639.60
|
|
600
|
13450
|
39549.50
|
The equilibrium price and quantity are determined by equating quantity demanded and
quantity supplied at given prices (Parkin & Bade, 2015).
The demand equation is: QD = 38650 – 42P
The supply function is: QS = -7909.89+79.1P
Equating demand and supply equation gives,
38650 – 42P = -7909.89 + 79.1
Or, 38650+7909.89 = 79.1P+ 42P
Or, 46559.89 = 121.1P
Or, P = 384.475
Putting value of P in the demand equation yields the equilibrium quantity as
Q = 38650 – 42P
= 38650 – (42*384.475)
= 38650 – 16147.95
= 22502.05
From the demand equation the factors affecting demand can be identified easily. These factors are price of the low calorie, frozen microwaveable food, the price of the substitute product that is product sold by its competitor, average income of local metropolitans, advertising expenditure and finally the average number of microwave sold in the given area. Additionally, taste and preference of the consumers can affect the demand (Rader, 2014). The supply low calorie frozen microwaveable food depends on the production technology. An advance technology can increase the supply without increasing cost. Price of other raw materials and number of producers present in the market affects the supply.
Short term and long term changes in the market condition affects both the demand and supply. For example, if consumer’s preference towards the product increases then demands for the product will rise and this will encourage the suppliers to increase their supply. In times of, downturn in market scenario both the demand and supply reduces.
Shift in the demand curve
Change in demand influencing factors other than price leads to a shift in then demand curve. The demand curve will shift to the rightward direction if
- There is an increase average income of people in the locality.
- Its competitor raises the price of the product.
- There is an increase in advertising expenditure.
- Preference of the consumer increases.
- Increase in the number of microwave sold.
The demand curve will shift inward if opposite happens. For example, in times of decrease in income people cut down their expenditure and thus reduce demand causing a leftward shift in the demand curve (Nicholson & Snyder, 2014) Same will happen if there is a decrease in the price of competitor’s product, decrease in advertising expenditure, people preference shift from the product to some other product and so on.
Shift in Supply Curve
As in case of demand the supply curve will shift to the rightward or leftward direction in case of change in factors other than price. The supply curve will shift rightward in times of expansion in supply (Frank, 2014). The factors causing expansion of supply are advancement of production technology, decrease in cost of production, relaxation of government policies like tax or regulation can cause the supply curve to shift rightward. In times of inefficient technology, rising production cost or stringent government policies supply curve inward.
References
Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.
Frank, R. (2014). Microeconomics and behavior. McGraw-Hill Higher Education.
Nicholson, W., & Snyder, C. M. (2014). Intermediate microeconomics and its application. Cengage Learning.
Parkin, M., & Bade, R. (2015). Introduction to Microeconomics.
Rader, T. (2014). Theory of microeconomics. Academic Press.
Wang, S. (2016). Microeconomic Theory (Book). Browser Download This Paper.
