Imagine that you work for the maker of a leading brand of low-calorie, frozen microwavable food that estimates the following demand equation for their product using data from 26 supermarkets around the country for April.
Note: The following is a regression equation. Standard errors are in parenthesis for the demand of widgets.
QD= - 5200 - 42P + 20Px + 5.2I + 0.20A + 0.25M
(2.002) (17.5) (6.2) (2.5) (0.09) (0.21)
R2= 0.55, N = 26 F= 4.88
Your supervisor has asked you to compute the elasticity for each independent variable. Assume the following values for the independent variables:
Q D = Quantity demanded (Quantity demanded of 3-pack units)
P (in cents) per case = Price of the product = 500 cents
PX (in cents) = Price of leading competitors product = 600 cents
I (in dollars) = Per capita income of the standard metropolitan statistical area (SMSA) where the supermarkets are located = 5500 $
A (in dollars) = Monthly advertising expenditures = $10,000
M = Number of microwave ovens sold in the SMSA in which thesupermarkets are located = 5,000
Demand and Supply Estimation
Compute the elasticity for each independent variable. Note: Write down all of your calculations.
When P= 500, M= 5000, A= 10,000, I = 5,500, C=600,
Applying the regression equation
QD= - 5200 42(500) + 20(600) + 5.2(5500) + 0.20(10000) + 0.25(5000) = 17,650
Price Elasticity (Ep) = (P/Q) (Q/P)
From the regression equation we get, Q/P = -42.
Therefore , Price Elasticity (Ep) = (P/Q) (-42) (500/17650) = -1.19, likewise,
(Microwave ovens Elasticity (EM) = (P/Q) (0.25) (5000/17650) = 0.07
Income-elasticity (EI) = (P/Q) (5.2) (5500/17650) = 1.62
Cross- price elasticity ( Ec) = 20(600/17560) = 0.68
Advertisement-elasticity (EA) = (P/Q) (0.20) (10000/17650) = 0.11
Determine the implications for each of the computed elasticity for the business in terms of short-term and long-term pricing strategies. Provide a rationale in which you cite your results.
From the calculation, price elasticity is 1,19. As such price increase of a commodity by 1 %, the quantity needed reduces by 1.19%. Hence, this means that the demand for the product is somehow elastic and a rise in consumer income might discourage buyers.
The income-elasticity, in this case, is determined by 1.62. As such, the quantity demanded can be boosted by 1.62% if the average region consumer income rises. This is a clear indication that this product is elastic and if the company identifies such, it can price its product higher if there is a rise in consumer income (Oseyomon & Ojeaga, 2010)).
Cross Price Elasticity is 0.68. in this case, the quantity demanded of this product will increase if there is an increment in the prices of products that the competitor sell product by 1%. This portrays that the prices of the competitor are inelastic and it is not necessary to pay much attention to competitors since their prices do not affect the overall sales.
Micro oven elastic is 0.07. As such, if ovens increase by 1% their quantity demanded will increase by mere 0.07%. Therefore, in such a scenario, the demand for this commodity is inelastic about the microwave.
The calculated advertisement-elasticity is 0.11. When the cost of advertisement raises, there is an increased demand for the product by 0.11%. In this case, the demand is somewhat inelastic to advertising. As a result, the firm will be forced to increase the prices of the product to recover the money it has incurred during advertisement and consumers might run away from the company. Hence, when the company carries out an intensive advertisement, it does not guarantee to increase the prices of the product since this could chase away consumers (Russo,Green, & Howitt, 2008).
Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.
There is no concern with the price of the competitor's product because of inelasticity to competitors product hence there is no effect on the sales of the company. The income elasticity is 1.62, and this implies that if the average income of the of individuals within the surrounding increase by 1%, the quantity demanded will also increase by 1.62%(Whelan, Msefer & Chung,2001). As such, the company can decide to raise the prices if there is a rise in the average income since the product is income inelastic. The calculated advertisement-elasticity is 0.11. When the cost of advertisement raises, there is an increased demand for the product by 0.11%.
The company can also decide to reduce the price to increase its market value. In absolute value, the price elasticity that is shown is bigger than 1, therefore, if the price of the product reduces, it leads to the increased demand for the product regarding percent and hence leading to an increased market share of the product. Conclusively, reduced price product leads to an increased market share of the product since price elasticity of demand is greater than one, i.e., 1.19 and hence the firm should consider cutting of prices (Whelan, Msefer & Chung,2001).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 of the Firm
Plot the corresponding supply curve on the same graph using the supply function Q = 5200 + 45P (Q= -7909.89+79.0989P) with the same prices.
Price Demand Supply
100 34450 0.11
200 30250 7910.11
300 26050 15820.11
400 21850 23730.11
500 17650 31640.11
600 13450 39550.11
Equilibrium Price and Quantity = 22,501.6
The Equilibrium price = 384
Outline the significant factors that could cause changes in supply and demand for the product. 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.
Q = -5200 - 42(P) + 20(600) +5.2(5500) +0.2(10,000) +0.25(5000)
Q = 38,650 42P
P = 38,650/42-Q/42
Q = 5200 =45P
P = - 5200/45 + Q/45
Thus, solving the demand and supply curves concurrently,
38,650 - 42P = 5200 + 45P
87P = 33,450
P = 384.48 AND
Q = 5200 + 45(384.48)
Q = 22,501.6
The equilibrium quantity of the commodity is 22, 501 unit while equilibrium price is 384 cents. Furthermore, the quantity and equilibrium price has been shown on the graph at the point where both demand and supply intercept. As shown in the demand equation, a change in the consumer income and the prices of substitute products means that the demand for low-calorie food might change. The changes might also be experienced due to changes in consumer preference. Also, changes in technology and number of suppliers can influences product supply.
5. Indicate the crucial factors that could cause rightward shifts and leftward shifts of the demand and supply curves.
Various critical factors might lead to the rightward and leftward shift. For example, when consumer income increases and complimentary product reduces, the demand curve shift rightward. A reduction in consumer income, rise in the price of a complementary product such as microwave ovens and decline in population can lead to leftward shift of the demand curve. Changes in technology in food processing industry, the increment in raw materials and cheap labor can lead to a rightward shift of the supply curve. Also, a rise in the price of labor and raw materials can result in a leftward shift (Russo,Green, & Howitt, 2008).Reference
Russo, C., Green, R., & Howitt, R. E. (2008). Estimation of supply and demand elasticities of California commodities.
Whelan, J., Msefer, K., & Chung, C. V. (2001). Economic supply & demand. MIT.
Price Of Elasticity. Retrieved 01/26/2016 from
http://www.economicsonline.co.uk/Competitive_markets/Price_elasticity_of_demand.htmlOseyomon, E. P., & Ojeaga, J. O. (2010). Globalization and Management: Issues and Concepts. African Research Review, 4(4).
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