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Price Elasticity of Demand and Demand Planning Strategies

## Price Elasticity of Demand and its impact on demand

1.Given that the price elasticity of demand (?) is 0.5,

a.How does demand change if the price is increased 1%

b.How does demand change if the price is decreased 5%

c.How does demand change if the price is decreased 50%

2.The Linear Price-Response Function. The total potential market for mini-jumbo-shrimp is D=150,000. We know that the demand decreases 5000 for every dollar increase in price. We also know that we can use a linear price-response function to approximate the consumer behavior. Find the following:

a.What is the PRF in terms of price p?

b.Draw it! (see below) Be sure to include P and d(0).

c.Find the price that maximizes revenue.

3.The Constant Elasticity Price-Response Function. Henry can sell 20,000 Happy Henry’s Hot Dogs if he sells them at \$1 each (which is close to the normal selling price). He buys them in bulk from a shady source for about \$0.10 each (mystery meat, yummm!). Henry knows that he can use a constant elasticity price-response function here to approximate the consumer behavior with ?=1. Find the following:

a.What is the PRF in terms of price p?  (hint: your answer should look like d(p)=…)

b.Henry keeps getting the same revenue despite any small promotion (price decrease) or price increase. Explain why this is happening.

c.Given a constant revenue around this price, should Henry charge a higher or lower amount for his hot dogs? (Justify your answer.)

4.The Logit Price-Response Function. An auto manufacturer can manufacture compact cars for an incremental cost of \$10,000 apiece. She faces a logit price-response function for sales in the next month, with parameters C=50,000, b=0.0005, and market price pm = \$16,000. It’s quite handy to note that in the Logit PRF, the market price, pm = -(a/b).

a.Keeping the price as variable p, what is the unit margin (contribution) from each additional sale? (Don’t overthink it! How much from selling one more?)

b.What is the exact price-response function, d(p), for this manufacturer? (not the generic formula)

c.At a price of \$14,000, what is the demand?

d.Roughly, what is the shape of the willingness-to-pay distribution?

e.What price maximizes Revenue?

Strategy Questions:

1.Accurate demand plans are crucial for a company. They are used by Finance to predict revenues and cash flows. They are used by Operations to help determine long-term capacity and short-term scheduling. How can Sales and Marketing (the organization that should oversee forming the demand plan) be held accountable for:

a.Underestimating the demand

b.Overestimating the demand

6.Explain the roles of demand plan “dashboards” and the benefits they offer.

7.What is the goal of “demand management” and “integrated business management”? What 4 repeating steps are used to execute a “proper” DM process?

8.Imagine you work for a large shoe company (Mikey). Your company currently sells many varieties of shoes for all kinds of stylish, athletic, or everyday wear. Mikey has just decided to expand into Elbonia, a country with about 20 million citizens (and about 20 inches of rain per week). Most people in Elbonia have very little disposable income and are always looking for a “good deal” (especially on tall mud-proof boots). However, there remains an affluent but small sector (about 1% of the population) who can afford expensive and stylish mud-proof shoes. Currently, the only supplier of mud-proof shoes is the Elbonian government, which uses a simple cost+5% margin pricing scheme. Much to your surprise, Mikey’s CEO has come directly to you (due to your awesome price management education) to get your reasoned opinions on the following items regarding the Elbonia expansion…

a.What would be Mikey’s best pricing method for the following (be sure to mention any caveats/conditions of your answer):

i.A new line of high-fashion mud-proof boots

ii.Gaining market share without a loss

b.For high-fashion mud-proof boots, what are your concerns and strategies on:

i.Potential product and customer segments

ii.Potential distribution channels