American Public University
1. Compute the elasticities for each independent variable. Note: Write down all of your calculations.
QD = - 5200 - 42P + 20PX + 5.2I + 0.20A + 0.25M
and Q = Quantity demanded of 3-pack units P (in cents) = Price of the product = 500 cents per 3-pack unit PX (in cents) = Price of leading competitor’s product = 600 cents per 3-pack unit I (in dollars) = Per capita income of the standard metropolitan statistical area (SMSA) in which the supermarkets are located = $5,500 A (in dollars) = Monthly advertising expenditures = $10,000 M = Number of microwave ovens sold in the SMSA in which the supermarkets are located = 5,000.
We can calculate the QD with the given values above.
QD=-5,200-42(500)+20(600)+5.2(5,500)+0.20(10,000)+0.25(5,000) = 17,650
Price elasticity of demand is [d(QD)/d(P)]/[QD/P]. d(QD)/d(P) is the derivative of the QD function subject to P (Hubbard & O'Brien, 2008), and we find -42. QD/P=17,650/500=35.3. Finally the price elasticity of demand is -42/35.3=-1.19.
Competitors’ products elasticity is [d(QD)/d(PX)]/[QD/PX]. d(QD)/d(PX) is the derivative of the QD function subject to PX, and we find 20. QD/PX=17,650/600=29.42. Finally the price elasticity of demand is 20/29.42=0.68.
Income elasticity demand is [d(QD)/d(I)]/[QD/I]. d(QD)/d(I) is the derivative of the QD function subject to I, and we find 5.2. QD/I=17,650/5,500=3.21. Finally the price elasticity of demand is 5.2/3.21=1.62.
Advertising elasticity is [d(QD)/d(A)]/[QD/A]. d(QD)/d(A) is the derivative of the QD function subject to A, and we find 0.20. QD/A=17,650/10,000=1.765. Finally the price elasticity of demand is 0.20/1.765=0.11.
Elasticity of total number of microwaves is [d(QD)/d(M)]/[QD/M]. d(QD)/d(M) is the derivative of the QD function subject to M, and we find 0.25. QD/M=17,650/5,000=3.53. Finally, the price elasticity of demand is 0.25/3.53=0.071.
2. Determine the implications for each of the computed elasticities for the business regarding short-term and long-term pricing strategies. Provide a rationale in which you cite your results.
The price elasticity of demand is -1.19, and it has a negative sign as expected due to the law of demand, and it is bigger than "1." It is an elastic demand, and customers are very sensitive to the changes in the price of the product (Pindyck & Rubinfeld, 2005). When the price increases by 1%; the demand decreases by 1.19%. That means if the company increases the price in the short-run, it might face a loss of customers because customers might quit using this product quickly. In the long-run, the price elasticity of demand increases relatively more because customers have the opportunity to find alternatives to this product, and probably they may find relatively more suitable options (Huang, Jones, Hahn, & Leone, 2010).
Competitors' products price elasticity is 0.68. It has a positive sign, and that means these products are substitutes. It is less than “1”; thus, the reaction of customers is weak to the changes in the prices of the leading competitor products (Pindyck & Rubinfeld, 2005). Therefore, we might say that when the price of the product increases, customers do not prefer other brands but cheap generic products. That means the company should differentiate its product for the customers from different income groups and even produce generic products with a different brand to increase its profit in the long-run. In the short-run, the company will face a high competition pressure from the generic products.
Income elasticity is 1.62, and that means customers are sensitive to the changes in their incomes. When their income increases by 1%; their demand increases by 1.62%. Subsequently, the product is relatively more purchased by the high income earning people. As I mention before, it is possible to differentiate product for satisfying individuals from the different income groups, and the company can differentiate its prices for various people.
Advertising elasticity is only 0.11. We can say advertising has a positive influence on the sales, but it is subtle. Therefore, the company needs to develop a different advertising strategy in the long-run. Even developing an advertising strategy parallel to product and price differentiation strategies might increase the market share and the profit of the company (Sternthal & Rucker, 2011).
The sale volume in the market elasticity is 0.071. That means when the market gets larger, it has a positive influence on the company, but it is very low. Therefore, the product seems like it lost attractiveness in the market. The company should carefully consider this situation; otherwise, it might lose the entire market share in the long-run.
Consequently, the company cannot increase its price in the short-run because it looks like the product has lost its attractiveness in the market, and the customers are quickly giving up on the product when they face a price increase. Therefore, the company needs to change its strategies in the long-run to protect and even extend its market share in the long-run. Product and price differentiation and developing an advertising and promotion campaign accordingly in the long-run might help the company protect and improve its market share (Lancaster, 1984).
3. Assume that all the factors affecting demand in this model remain the same, but that the price has changed. Further assume that the price changes are 100, 200, 300, 400, 500, 600 cents. Plot the demand curve for the firm. Plot the corresponding supply curve on the same graph using the following supply function Q = -7909.89 + 79.1P with the same prices.
Diagram 1: Demand and Supply Lines
For finding the equilibrium, we need to equalize the demand to the supply.
QD = - 5200 - 42P + 20PX + 5.2I + 0.20A + 0.25M= Q = -7909.89 + 79.1P=QS
QD=-5,200-42P+20(600)+5.2(5,500)+0.20(10,000)+0.25(5,000) = -7909.89 + 79.1P=QS
QD=38,650-42P=-7,909.89+79.1P=QS and if we solve for P, we find that P=384.47. We can place this equilibrium price into the supply equation and find the equilibrium quantity. QS=-7,909.89+79.1*384.47=22,501. Finally, the equilibrium price is 384.47, and the equilibrium quantity is 22,501.
4. Outline the significant factors that could cause changes in supply and demand for the low-calorie, frozen microwavable food. Determine the primary manner in which both the short-term and the long-term changes in market conditions could impact the demand for, and the supply, of the product. Indicate the crucial factors that could cause rightward shifts and leftward shifts of the demand and supply curves for the low-calorie, frozen microwavable food.
The changes in the price of the product cause a move on the demand and the supply line without any shift. The changes in the other factors including advertising, competitor products' prices, sale volume in the market, and income other than the price of the product might cause a shift of the demand to the right or left. Considering that all these factors have positive signs in the demand function when they increase, the demand shifts to the right and when they decrease the demand shifts to the left. The supply curve shifts to the right or the left if the cost structure changes. If the costs increase, then it moves to the left and vice versa.
References
Huang, M., Jones, E., Hahn, D., & Leone, R. (2010). Assessing price elasticity for private labels and national brands by store locations. Journal Of Revenue And Pricing Management, 11(2), 175-190. http://dx.doi.org/10.1057/rpm.2010.32
Hubbard, R. & O'Brien, A. (2008). Microeconomics (1st ed.). Upper Saddle River, N.J.: Pearson Prentice Hall.
Lancaster, K. (1984). Brand Advertising Competition and Industry Demand. Journal Of Advertising, 13(4), 19-30. http://dx.doi.org/10.1080/00913367.1984.10672913
Pindyck, R. & Rubinfeld, D. (2005). Microeconomics (1st ed.). Upper Saddle River, N.J.: Pearson Prentice Hall.
Sternthal, B. & Rucker, D. (2011). Advertising strategy (1st ed.). Acton, MA: XanEdu Publishing, Inc.
