Imagine that you work for the maker of a leading brand of low-calorie, frozen mi
ID: 1189630 • Letter: I
Question
Imagine that you work for the maker of a leading brand of low-calorie, frozen microwavable food that estimates the following demand equation for its product using data from 26 supermarkets around the country for the month of April.
For a refresher on independent and dependent variables, please go to Sophia’s Website and review the Independent and Dependent Variables tutorial, located at http://www.sophia.org/tutorials/independent-and-dependent-variables--3.
Option 1
Note: The following is a regression equation. Standard errors are in parentheses for the demand for 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 elasticities for each independent variable. Assume the following values for the independent variables:
Q = Quantity demanded of 3-pack units
P (in cents) = Price of the product = 500 cents per 3-pack unit
PX (in cents) = Price of leading competitor’s product = 600 cents per 3-pack unit
I (in dollars) = Per capita income of the standard metropolitan statistical area
(SMSA) in which the supermarkets are located = $5,500
A (in dollars) = Monthly advertising expenditures = $10,000
M = Number of microwave ovens sold in the SMSA in which the
supermarkets are located = 5,000
Option 2
Note: 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
Your supervisor has asked you to compute the elasticities for each independent variable. Assume the following values for the independent variables:
Q = Quantity demanded of 3-pack units
P (in cents) = Price of the product = 200 cents per 3-pack unit
PX (in cents) = Price of leading competitor’s product = 300 cents per 3-pack unit
I (in dollars) = Per capita income of the standard metropolitan statistical area
(SMSA) in which the supermarkets are located = $5,000
A (in dollars) = Monthly advertising expenditures = $640
Compute the elasticities for each independent variable. Note: Write down all of your calculations.
Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies. Provide a rationale in which you cite your results.
Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.
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.
Plot the corresponding supply curve on the same graph using the following MC / supply function Q = -7909.89 + 79.1P with the same prices.
Determine the equilibrium price and quantity.
Outline the significant factors that could cause changes in supply and demand for the low-calorie, frozen microwavable food. 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.
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.
Explanation / Answer
Option 1:
The demand function is
Q = -5200 – 42P + 20PX + 5.2I + 0.20A + 0.25M
Differentiate the demand function with respect to P.
Q/P = 42
Differentiate the demand function with respect to PX.
Q/PX = 20
Differentiate the demand function with respect to I.
Q/I = 5.2
Differentiate the demand function with respect to A.
Q/A = 0.20
Differentiate the demand function with respect to M.
Q/M = 0.25
For the given values of the independent variables, the quantity demanded is
Q = -5200 – 42(5) + 20(6) + 5.2(5500) + 0.20(10000) + 0.25(5000)
= 26,560
Calculate the price elasticity of demand.
Ed = Q/P × P/Q
= (-42) × 5/26,560
= 0.0079
Calculate the cross-price elasticity of demand.
EPX = Q/PX × PX/Q
= 20 × 6/26,560
= 0.0045
Calculate the income elasticity of demand.
EI = Q/I × I/Q
= 5.2 × 5500/26,560
= 1.0768
Calculate demand elasticity for A.
EA = Q/A × A/Q
= 0.20 × 10,000/26,560
= 0.0753
Calculate demand elasticity for M.
EM = Q/M × M/Q
= 0.25 × 5,000/26,560
= 0.0451
The price elasticity of demand is 0.0079, i.e., inelastic. This means the total expenditure of the consumer is directly related with price. Since a rise in price will increase the total revenue of the firm, the firm’s pricing strategy is to increase the price.
Option 2:
The demand function is
Q = -2000 – 100P + 25PX + 10I + 15A
Differentiate the demand function with respect to P.
Q/P = 100
Differentiate the demand function with respect to PX.
Q/PX = 25
Differentiate the demand function with respect to I.
Q/I = 10
Differentiate the demand function with respect to A.
Q/A = 15
For the given values of the independent variables, the quantity demanded is
Q = -2000 – 100(2) + 25(3) + 10(5000) + 15(640)
= 57,475
Calculate the price elasticity of demand.
Ed = Q/P × P/Q
= (-100) × 2/57475
= 0.0035
Calculate the cross-price elasticity of demand.
EPX = Q/PX × PX/Q
= 25 × 3/57,475
= 0.0013
Calculate the income elasticity of demand.
EI = Q/I × I/Q
= 10 × 5000/57,475
= 0.8699
Calculate demand elasticity for A.
EA = Q/A × A/Q
= 15 × 640/57,475
= 0.1670
The price elasticity of demand is 0.0035, i.e., inelastic. This means the total expenditure of the consumer is directly related with price. Since a rise in price will increase the total revenue of the firm, the firm’s pricing strategy is to increase the price.
A price cut will lead to fall in the firm’s revenue. Therefore, the firm should not cut its price.