Abstract
Using the regression equation and given values of independent variables, we estimated the elasticity of each of them and ascertained that the product is highly elastic to price levels and therefore, the firm can consider to decrease the price levels in order to increase their market share. At the same time, cross elasticity and income elasticity were also significant in relation to the demand of the product, although advertisement expenditure has negligible impact on the product’s demand. Hence, own price, price of related goods and income of consumer are three major factors which the firm should incorporate while framing its product pricing.
Compute the elasticities for each independent variable
Option 1:
QD= - 5200 - 42P + 20PX + 5.2I + 0.20A + 0.25M
Here, P = 500, PX = 600, I = 5500, A = 10000 and M = 5000,
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 the supermarkets are located = 5,000
Putting these values in the regression equation,
QD= -5200 - 42*500 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000 = 17650
Price elasticity = (P/Q )*(dQ/dP)
So, price elasticity EP= (P/Q) * (-42) = (-42) * (500 / 17650) = -1.19
Likewise, EPX= 20 * 600 / 17650 = 0.68
EI= 5.2 * 5500 / 17650 = 1.62
EA= 0.20 * 10000 / 17650 = 0.11
Option 2:
QD = -2,000 - 100P + 15A + 25PX + 10IHere, P = 200, PX = 300, I = 5000, A = 640 and M = 5000,
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
Putting these values in the regression equation,
QD = -2,000 – 100(200) + 15(640) + 25(300) + 10(5000)
= -2000-20000+ 9600+ 7500+ 50000
= 45100
Price elasticity = (P/Q )* (dQ/dP)
So, price elasticity EP= (P/Q) * (-100) = (-100) * (200 / 45100) = -0.18
Likewise, EPX= 25 * 300 / 45100 = 0.68
EI= 10 * 5000 / 45100 = 1.62
EA= 0.20 * 640 / 45100 = 0.11
Note: The discussion about all the questions hereafter is on the basis of calculation performed in Option 1.
Q: Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies
a) Price Elasticity
Referring to the calculations above, we can see that price elasticity was calculated at -1.19. This indicated that a 1% change decrease the price level will increase the quantity demanded by 19%. Therefore, these figures indicate that the demand for this product is elastic and the company can lure its customers by decreasing the price levels while the increase in price levels will have the opposite impact. The impact of price elasticity should be considered, both from long-term and short-term perspective.
b) Cross Elasticity
Represented by the variable, PX, cross elasticity of the product was estimated to be 0.68. Stated otherwise, if the price of the competitor product increase by 1%, the demand for this product will increase by 0.68% and if the competitor firm decreases the price level by 1%, demand for this product will decrease by 0.68%. Therefore, the company must be wary about the pricing strategies of its competitor and incorporate the observations in its short-term and long-term plans.
c) Income Elasticity
Represented by the variable, I, income elasticity indicates the change in demand of the product in response to changes in the income of the consumer. As noticed from the calculations above, the income elasticity of the product is estimated to be 1.62. This indicates that a 1% rise in the income level of consumers, will increase the demand by 1.62%. Hence, we can infer that demand is income elastic and while this factor may be negligible in the short-term, however, in the long-term, the company can increase the price of its product if the income level of the consumers increases, vice-versa.
d) Advertisement Elasticity
Represented by the variable, A, advertisement elasticity refers to the elasticity of the product in response to the advertisement expenditure. Our calculation revealed that advertisement has a positive correlation with the demand of the product, however, the impact is only marginal. With a 1% additional expenditure on advertisement, demand will only increase by 0.11%. However, still, the influence and necessity of the advertisement expenditure cannot be ignored.
Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.
As discussed previously, the coefficient of price elasticity is -1.19. In other words, if the company decreases the price of the product by 1%, the quantity demanded for it will increase by 1.19%. Therefore, with the product demand being elastic and sensitive to price change, the company can decrease the price levels to lure the customers and gain additional market share.
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.
Given demand equation:
QD= - 5200 - 42P + 20PX + 5.2I + 0.20A + 0.25M
Here, P = 100-500, PX = 600, I = 5500, A = 10000 and M = 5000,
Calculating the demand at various prices while other factors are assumed to be constant:
At Price=$100QD= -5200 - 42*100 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
= -5200-4200+ 12000+ 28600+ 2000+ 1250
= 34450
At Price=$200QD= -5200 - 42*200 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
= -5200-8400+ 12000+ 28600+ 2000+ 1250
= 30250
At Price=$300QD= -5200 - 42*300 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
= -5200-12600+ 12000+ 28600+ 2000+ 1250
= 26050
At Price=$400QD= -5200 - 42*400 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
= -5200-16800+ 12000+ 28600+ 2000+ 1250
= 21850
At Price=$500QD= -5200 - 42*500 + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
= -5200-21000+ 12000+ 28600+ 2000+ 1250
= 17650
Plot the corresponding supply curve on the same graph using the following MC / supply function Q = -7909.89 + 79.1P with the same prices.
Given supply equation:
Q= -7909.89+ 79.10P
Estimating supply at different prices:
At Price=$100Q= -7909.89+ 79.1(100)
= 0
At Price=$200Q= -7909.89+ 79.10P
= -7909.89+ 79.10(200)
= 7910.11
At Price=$300Q= -7909.89+ 79.10P
= -7909.89+ 79.10(300)
= 15820.11
At Price=$400Q= -7909.89+ 79.10P
= -7909.89+ 79.1(400)= $23730.11
At Price=$500Q= -7909.89+ 79.10(500)
= $31640.11
Determine the equilibrium price and quantity.
Referring to the above table and graph, we can see that the equilibrium price lies between $300-$400 and equilibrium quantity lies between $15820-$23730.
Below we have outlined the factors that affect the demand and supply of the low-calorie microwavable food:
Factors affecting demand
Price of the product
Price of related goods, both substitute goods and complimentary goods
Income of the consumers
Consumer’s tastes and preferences
Consumer know-how about the product
Expectation related to the future price of the product
Advertisement expenditure
Nutritional aspects of the product
Population size and distribution
(Karlan and Zinman, 2005)
Factors affecting supply
Own price of the commodity
Price of other related commodities
Price of factors of production
Taxation rules of the government, both direct and indirect
Tax subsidies and related laws
Total suppliers in the industry
Nature of events, natural calamities, such as earthquake and cyclone can also affect the supply
The time span either short run or long run
(Karlan and Zinman, 2005)
Important to note, while the demand and supply of a product is affected by numerous factors, however, primarily, price is the main factor. In the short-term as well as in the long-term, price is the main factor that primarily affects the demand and supply of the product. However, the impact is opposite because while the consumers look for the lowest possible price, suppliers curtail the supply at the lowest price. Therefore, it is the market forces that ensure that the product is priced at an equilibrium level where consumer and producer surplus is maximized.
(Karlan and Zinman, 2005)
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.
Shift in the demand and supply curves are brought in by factors other than the price of the product. Discussed below are such factors:
Rightward shift in the demand curve:
Increase in price of substitute good
Decrease in the price of related good
Favorable taste and preference for the good
Increase in the income of the consumer
Unfavorable expectations for the price in the future
Increase in employment rate and consequently, demand for low-calorie, frozen microwavable food
Rightward shift in the supply curve:
Improvement in production technology for producing the good
Decrease in the price of factors of production
Decrease in excise duty on production of the good
Increase in number of firms producing the good
References
Dwiwedi, D. (2002). Microeconomics: Theory And Applications. Pearson Education.
Karlan, D. and Zinman, J (2005). Elasticities of Demand for Consumer Credit: Center discussion paper No.926, Economic Growth Centre. Yale University. http://www.eea-esem.com/papers/eea-esem/2003/968/householdEEA.pdf
Kaplan. (2011). Elasticity. In Schweser notes for CFA Exam (pp. 8-22). USA: Kaplan Inc.
