McBurger hires you as a consultant to advise on its best strategy. You estimate
ID: 1138264 • Letter: M
Question
McBurger hires you as a consultant to advise on its best strategy. You estimate monthly demand for its burgers to be:
Qd = 26,000 - 10,000P + 4,000Pc -.8Y +0.5A
where the independent variables are respectively: P, price of McBurger’s burgers, PC, price of competitors' burgers, Y, per capita income, and A, McBurger’s advertising budget.You observe that competitors have, on average, priced their burgers at $3.50, while McBurger charges $2.50.Per capita income level in the store's geographic market is $15,000.McBurger's advertising expenditure is $20,000 per month.McBurger currently sells 13,000 burgers/month.
1. How much revenue does McBurger currently earn based on the information above? [2]
2. Is McBurger maximizing its revenues under current conditions? [Grading here is based solely on your calculations.] [2]
3. Based on the data given, McBurger should _______________ its advertising expenditure. [2]
Possible answers:
a) raise
b) lower
c) not change
d) we cannot say
4. What advice can you offer McBurger, based on the above information? [4]
Explanation / Answer
Monthly demand for burgers is Qd = 26,000 – 10,000P + 4,000Pc – 0.8Y + 0.5A
We are given that Pc = $3.50, P = $2.50 and Y = $15,000. Also, A = $20,000 per month. Current level of quantity demanded and sold Qd = 13,000 burgers/month.
1. Revenue earned = Price x quantity = $2.50 x 13,000 = $32,500
2. For revenue maximization, we find the implicit demand function which is
Qd = 26,000 – 10,000P + 4,000Pc – 0.8Y + 0.5A
Qd = 26,000 – 10,000P + 4,000*3.50 – 0.8*15000 + 0.5*20000
Qd = 38,000 – 10,000P
P = 38,000/10,000 – Q/10,000
P = 3.8 – 0.0001Q
Revenue function = PQ = 3.8Q – 0.0001Q2
Marginal revenue is the derivative of total revenue so MR = 3.8 – 0.0002Q. Now when revenue is maximized, MR is 0. So we have 3.8 – 0.0002Q = 0 which gives Q = 19000 units. This implies that the firm is not selling the revenue maximizing quantity because its sales are only 13,000 per month. Hence it is not maximizing its revenue.
3. It can increase its advertising expenditure so that it can sell more. Select raise.
4. We find that from the demand function, slope is -10000 and so elasticity of demand = slope x price / demand = -10000*2.5/13000 = -1.92. Since demand is elastic, the firm should reduce its price so that it can raise its revenue.