A firm with an objective to progress has to make a constant endeavor to expand its operations and increase its returns. Product innovation, technological progress and unique sales promotion programs helps the firm to expand its market share. The firm requires a continuous flow of information on the trends in demand, consumer’s choice and the competitive element present in the market to take strategic decisions on price, supply and sales promotion measures. In this article we discuss how a firm decides on price and the quantity to be supplied based on market survey data. We take the example of a firm that is going to arrive at the equilibrium price and quantity with the help of the survey data provided to it.
The firm that we are discussing here produces a low-calorie frozen food. We have with us the result of survey conducted at 26 super markets. The regression result of the survey has been presented below:
Option 1Note: The following is a regression equation. Standard errors are in parentheses for the demand for widgets.QD = - 5200 - 42P + 20PX + 5.2I + .20A + .25M(2.002) (17.5) (6.2) (2.5) (0.09) (0.21)R2 = 0.55 n = 26 F = 4.88
Q = Quantity demanded of 3-pack unitsP (in cents) = Price of the product = 500 cents per 3-pack unitPX (in cents) = Price of leading competitor’s product = 600 cents per 3-pack unitI (in dollars) = Per capita income of the standard metropolitan statistical area(SMSA) in which the supermarkets are located = $5,500A (in dollars) = Monthly advertising expenditures = $10,000M = Number of microwave ovens sold in the SMSA in which thesupermarkets are located = 5,000
Option 2Note: The following is a regression equation. Standard errors are in parentheses for the demand for widgets.
QD = -2,000 - 100P + 15A + 25PX + 10I(5,234) (2.29) (525) (1.75) (1.5)R2 = 0.85 n = 120 F = 35.25
Q = Quantity demanded of 3-pack unitsP (in cents) = Price of the product = 200 cents per 3-pack unitPX (in cents) = Price of leading competitor’s product = 300 cents per 3-pack unitI (in dollars) = Per capita income of the standard metropolitan statistical area(SMSA) in which the supermarkets are located = $5,000A (in dollars) = Monthly advertising expenditures = $640
We have been provided with two regression results. We prefer to take the first one as it includes number of microwaves as explanatory variable. The second regression does not take this variable into account and can suffer from omitted variable bias.
We substitute the values of the independent variables provided to us in the above regression equation. We get the demand for the product as:
QD = -5200 -42*500 + 20*600 + 5.2*5500 + 0.20*10000 + 0.25*5000 = 17650.
Thus we see that the demand for the product at the given prices, income, advertisement expenditure and the number of microwaves sold is 17650. Now let us analyze the demand.
Computation of elasticities of demand: We begin with the computation of the elasticity of demand with respect to each independent variable present in the regression equation.
Elasticity with respect to price:
Ep = dq/dp*p/q = -42*500/17650 = -1.2
Elasticity with respect to the price of the leading competitor’s product:
Epx = dq/dpx*px/q =20*600/17650 = 0.67
Elasticity with respect to the income of the consumers
EI = dq/dI*I/q = 5.2*5500/17650 = 1.62
Elasticity with respect to advertisement expenditure:
EA = dq/dA*A/q = 0.11
Elasticity with respect to the number of microwaves sold:
EM = dq/dM*M/q = 0.07
Interpretation of the elasticities: We have computed and presented the values of the elasticity of demand above. Now let us discuss what these values imply and how it can affect the firm.
First of all wee see that the price elasticity of demand is -1.2. This means as price increases by 1% demand falls by 1.2%. The elasticity is greater than one which means the the good has an elastic demand .
The elasticity with respect to the price of the competitor’s product is 0.67 which is less than one. That means the demand for our firm’s product is inelastic to the change in the price of the close substitute. As the price of the close substitute decreases there will be less than proportionate decrease in the demand for the low-calorie widgets. This further implies that the product of our firm possesses some characteristics which are distinguishable from the other products in the market and the consumers have a preference for this uniqueness of the product.
The value of the income elasticity clearly shows that the good is income elastic. The income elasticity is 1.62 which is greater than 1 and fairly high. Thus, the demand for the good increases with the increase in the income of the consumers. It is a normal good .
Elasticity with respect to advertisement expenditure is quite low at 0.11. The demand is inelastic to the changes in the advertisement expenditure. Advertisements seem to have little impact on the demand for the product. There can be two reasons for this. Either the advertisements are inefficiently produced and so becomes ineffective or the consumers rely more on the quality of the product produced by the firm and are not swayed by advertisements. This implies the firm should not spend much on advertisements at the present moment.
The elasticity with respect to the number of microwaves sold is the lowest among the five independent variables that we are analyzing here. The demand is inelastic to the change in the number of microwaves sold. Thus, an increase in the number of microwaves sold will not increase the demand for the widgets significantly.
Let us now discuss whether the firm should adopt any price cutting strategy. We can see that the demand is price elastic. That means a decrease in price will lead to a more than proportionate increase in the quantity demanded. This increase will lead to an increase in the revenue earned by the firm. So, it is advisable to the firm to lower the price so that the demand increases and so does its earnings.
Let us now derive the demand curve for the product. As a first step we are going to express the quantity demanded as a function of the price of the product. The demand function is given as:
QD = 38650 – 42P
The corresponding demand curve can be found out by putting different values of price in the function and finding the quantity for the prices. We have taken the prices as 100, 200, 300, 400, 500 and 600 cents. The demand curve is shown below:
Now let us construct the supply curve. For this we need the supply function. The supply function as provided to us is:
Q = -7909.89 + 79.1P
We derive the supply curve by putting different values of price in the above supply function as we had done in the case of the demand curve. The supply curve thus obtained has been presented below:
We can see that the equilibrium price is between $350 and $400 and equilibrium quantity is between 20000units and 25000 units. The equilibrium price and quantity can also be derived mathematically as shown below:
38650 -42P = -7909.89 + 79.0989P
Or, P = $384.5
QD = 22500.73
We can see that the mathematical result matches the equilibrium values found in the graph.
In the previous section we have found the demand and supply curveand the equilibrium price and quantity. Now let us discuss the factors that affect demand and supply. We can see that there is a negative relation between the prce of the product and the quantity demanded. As price changes there is movement along the demand curve. The other four factors bear a positive relationship with the quantity demanded. An increase in income, price of the close substitute, advertisement expenditure and the number of microwaves sold will cause a rightward shift in the demand curve indicating increase in demand and vice versa. Apart from these factors there can be other important factors that can affect demand.
In the real world we have seen that there is a recent trend shift in preference towards fresh food from processed food frozen food. Some people have a notion that frozen food have low nutritional quality and some adverse impact . This notion can lead to a leftward shift in the demand curve. But if the lifestyle becomes faster with a greater number of working couples the demand for frozen food will increase to save time for cooking. Also increased health awareness can cause a rightward shift in the demand curve as people would prefer this low-calorie product.
Supply has a direct relationship with the price of the product. Supply curve can shift due to change in the price of raw materials. If the price of the vegetables, spices, meat etc. required for this product, rises the cost of production increases leading to a leftward shift in the supply curve. If the government provides subsidy on this product the supply curve can shift rightwards.
References
Henderson, J. M., & Quandt, R. E. (1980). Microeconomic Theory: A Mathematical Approach. McGraw Hill.
Koutsoyiannis, A. (2003). Microeconomics. Pulgrave Macmillan.
Pindyck, R., & Rubinfield, D. (2009). Microeconomics (7th ed.). Prentice Hall.
Woolridge, J. M. (2009). Econometrics. Cengage Learning.
