Report on Price Elasticity, Costs of Production, Market Power and Business Strategy

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George Washington University
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Task 2: Elasticity

For each pair of items below, determine which product is more price elastic (would have a higher price elasticity of demand in absolute value). Explain your answer including identifying the determinant of elasticity.

1. Carton of milk and the purchase of high quality jewelry

Carton of milk is more price elastic. When price of carton increases, people will buy for alternative source of protein such as meat, beans hence demand for the product decline. Few people buy Jewelry. However, the increase in prices attracts more people who embrace uniqueness.


The proportional change in demand from q1 to q2 is relatively larger than the proportional change in price from p1 to p2. Price responds in a smaller manner compared with the demand

2. A bag of oranges and a tank of petrol for your car

A bag of oranges is price elastic. There are varieties of fruits and thus an increase in prices of oranges causes a push on the consumers to buy pineapples, and watermelon, mangoes as alternatives.


The proportional change in demand from q1 to q2 is relatively smaller in proportion in change in price from p1 to p2. Relatively inelastic demand has a practical application as demand for many of products respond in the same manner with respect to change in their prices.

3. Tiptop bread or all brands of bread (bread in general)

A brand of bread is price elastic because of the many brands of bread in the market. However, the bread in general is price inelastic because there is no alternative.

the movement in price from OP1 to OP2 and OP2 to OP3 does not show any change in the demand of a product (OQ). The demand remains constant for any value of price. Perfectly inelastic demand is a theoretical concept and cannot be applied in a practical situation.

Use the following graph to answer questions 4 and 5.

Use the mid-point formula to calculate the price elasticity for demand curve D1 between points A and C. Then calculate the price elasticity for demand curve D2 between points A and B. Which curve is more inelastic? Must show workings and explain your answer.

P.E.D= % Change in quantity/ %change in price

%Change in quantity demanded= 300-200= 100/200= *100= 50%

%change in price= 3.00-2.50=1.50/2.50* 100= 60%

PED D1= 50/60= -0.833

P.D.E D2= 225-200/200*100= 12.5%

3.00-2.50/2.50*100= 60%

P.E.D = 12.5/60= -0.208

Curve D2 is more price elastic because a small change in piece results in big change in demand.

5. If the price falls from $3.00 to $2.50 what will be the change in revenue if the demand curve is D1? Now calculate the change in revenue if demand is D2. Compare the two and explain the difference. Must show workings

Fall in price from 3.00 to 2.50 for D1, Causes an increase in revenue by 100. For D2, the fall in price to 2.50 causes an increase in revenue by 25. Curve D2 is price inelastic. 6. Is the gross-price elasticity of demand between petrol and fuel-efficient small cars positive or negative? Is the cross-price elasticity of demand between petrol and large not-very-fuel-efficient SUVs positive or negative? Briefly explain.

The cross-price elasticity of demand of fuel-efficient vehicles and demand for petrol is positive. An increase in price of petrol results in an increase in demand for fuel-efficient vehicles to cope with the high costs. For vehicles that are not fuel efficient the cross price elasticity is negative because people will quite buying such vehicles

Task 3: Costs of Production

Explain whether the following events in questions 1 to 3 will affect fixed costs or variable costs (make sure you justify your answer):

1. Samsung signs a new contract changing the price it pays for transistors that are used in its mobile phones.

It affects variable cost. The change in price for transistors affects the prices of the sum sang devices.

2. The federal government applies a levy per mobile phone provider of $1, 000, 000

Not change as output changes it will always be $1, 000, and 000. Therefore, the levy is a fixed cost.

3. Samsung decides to increase the amount it spends on designing the next version of its mobile phone.

It affects fixed cost. Designing new version of mobile phone alters the variable cost.

4. Which of the following is an example of a firm experiencing technological change? (A) The firm reduces its workforce and is able to maintain its initial level of output; or (B) The firm rearranges the layout of its factory and finds that by using its initial set of inputs it can produce exactly as much as before.


5. Suppose the total cost of producing 10 000 tennis balls is $30 000 and the fixed cost is $10 000. What is the variable cost? When output is 10 000, what are the average variable cost and the average fixed cost. Assuming that the cost curves have the usual shape, is the dollar difference between the average total cost and the average variable cost greater when the output is 10 000-tennis balls or when the output is 30 000-tennis balls? Explain.

Variable cost = total cost- fixed cost = %20,000

Average cost= 20000/10000= 2

Average fixed cost= 10000/10000= 1

No, when the output is 10000, the average variable cost and the average fixed cost when the output is 30,000

6. Online booksellers have captured a very large portion of the retail book market over the past several years. Companies that have a large online presence, such as Amazon and Barnes & Noble, now dominate this market. Over the past 15 years, the number of independent bricks and mortar bookstores has fallen. Briefly explain what role costs may have played in explaining the large decline in independent booksellers. Use a graph to explain your answer.

The companies such as amazon command the market because it has money. The new companies has to invest much on advertising to cope with the popular companies.

Task 4: Market Power and Business Strategy

A sceptic says, marketing research and brand management are redundant. If a company wants to find out what customers want, it should simply look at what they are already buying. Do you agree with the comment? Explain (hint under what conditions are firms able to earn economic profits).

I agree with the statement. Customer needs is a priority and market research should focus on meeting the needs of the customers.

What is a price taker? When are firms likely to be price takers?

A Price taker refers to a company that accepts the existing prices in the market. Firms are price takers when they cannot influence the market.

To maximize profit, a firm should produce the quantity where the difference between marginal revenue and marginal cost is the greatest. If a firm produces more than this quantity, then the profit made on each additional unit will be falling. Briefly explain whether you agree with this reasoning.

I agree. A company-producing surplus will run at loss. The surplus products are loss when there are no clients.

Godrickporter and Star Connections are the only two airport shuttle and limousine rental service companies in the mid-sized town of Odrick Hollow. Each firm must decide whether to increase its advertising spending to compete for customers. The following figure shows the payoff matrix for this advertising game. Answer questions 4, 5 and 6.

Define dominant strategy. Is there a dominant strategy for Godrickporter and, if so, what is it? Explain.

Dominant Strategy is a strategy that gives the most utility. The dominant strategy in Gofrickporter is increasing advertising budget because it give the highest profit.

Let's suppose the game starts with each firm adhering to its original budget so that Godrickporter earns a profit of $6000 and Star Connections earns a profit of $12 000. Is there an incentive for any one firm to increase its advertising budget? Explain.

Yes, the secret of earning more profits is increasing advertising budget. Therefore, Godrickporter has a chance to earn more by increasing the advertisement cost..

Define Nash equilibrium. What is (are) the Nash equilibrium(s) in this game? Explain.

Nash equilibrium is a stable state where one company does not gain much during a change in strategy because the strategies of other companies did not change. Both the star connections and Godrickporter increased the Advertising budget and there no much change.

Read the following excerpt and answer questions 7 and 8

CSR and Boral have announced the intention to form a joint venture of Australian east coast brick operations, citing reduced brick usage as a major cause for consolidation. The companies have proposed to combine brick operations in New South Wales, Victoria, Queensland, South Australia, Tasmania and the ACT. The move is subject to clearance by the Australian Competition and Consumer Commission (ACCC). A joint statement from the companies explains brick demand in Australia has experienced a sustained structural decline, with bricks becoming an increasingly smaller component of the broader cladding market. Despite a general increase in construction activity over this period, total brick production in Australia has fallen by 46 per cent from its peak in 1981, according to Boral and CSR. Author David Wheeldon Source: Infolink web site ( accessed 8th April 2014

7.Using the concept of economies of scale to explain why the two companies MUST merge due to the significant fall in demand (start by explaining why CSR and Boral were able to operate as separate companies before the fall in demand). For this question assume that CSR and Boral are the only two companies in the market and form an oligopoly (Hint: think about the cost curves and the market demand curve)? As part of this question, you need draw and explain the appropriate graph that outlines the argument in support of the merger.

The merge will reduce competition in the market. The merge will be price markers because of the power to influence the market.

If the joint venture is allowed to proceed, how would you describe the new market? What would be the impact on price, quantity, and profit? Explain using a graph.

There will be an oligopolistic competition in the market. The merge will earn will earn supernormal profits because it becomes the price markers. The quantity of goods supplied will increase and the price of commodities will rise because the merger will influence th...

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