Download Compute the elasticities for each independent variable. Note: Write

Compute the elasticities for each independent variable. Note: Write down all of
your calculations.
The given regression equation is QD = - 5200 - 42P + 20PX + 5.2I + .20A + .25M.
Using the regression equation and from the given values of P = 500, C = 600, I = 5500, A
= 10000 and M = 5000; the quantity demanded can be calculated as, QD = -5200 - 42*500 +
20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000 = 17650
Price elasticity can be calculated from the formula E = (P/Q)*(dQ/dP)
We have, (DQ/DP) = -42 ; for price of the widget (from the regression equation).
Hence EP = (500/17650)*(-42) = -1.19
Similarly for other independent variables,
Cross Price elasticity, EPX = (600 / 17650)*20 = 0.68
Income Elasticity, EI = (5500 / 17650)*5.2 = 1.62
Advertisements Elasticity, EA = (10000 / 17650)*0.20 = 0.11
Micro-oven Elasticity, EM = (5000 / 17650)*0.25 = 0.07
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.
As the Price elasticity is equal to -1.19, which implies that any 1 percent increase in price
of the widget will lead to the demand of the widget reduced by -1.19 percent. As the increase in
price only impacts the demand by a little, the price elasticity can be called as ‘somewhat elastic’.
Though the decrease in demand is not much due to the increase in price, it may not drive many
customers away, but if the widget market is huge, the widget may lose a lot of customer base.
As the Elasticity associated with cross price is 0.68, which implies that any increase in
price of the competitor’s widget gets increased by 1%, and then the demand for this widget gets
increased by 0.68%. Hence it can be inferred that the Cross Price elasticity is ‘fairly inelastic’
and the company shouldn’t worry about the competitor’s price since the price of the competitor’s
widget really doesn’t affect the widget sales of the company.
As the Elasticity for Income is 1.62, which implies that any 1% rise in the incomes of the
widget’s consumer base or target area boosts the demand for the widget by 1.62 %. Hence the
demand can be said as ‘moderately elastic’ to income. Therefore, if the incomes of the consumer
base buying the widget rise, the company can raise the price of the widget.
As the elasticity for advertisement is 0.11, which implies that if the advertisement
expenses rise by 1%, then the widget sales will rise by only a measly 0.11%. This means that
demand is ‘inelastic’ to advertisement. So to increase the widget sales, if the company spends
more on advertisements, this doesn’t exactly mean that the demand will increase and also, it
should be remembered that any increase in price of the widget due to the additional advertising
expenses incurred will only lead to the loss in customers.
The elasticity for micro ovens is 0.07, which implies that any 1 % increase in the sales of
micro-ovens only results in 0.07% increase in the sales of widgets and hence it can be said that
demand of widgets is highly inelastic to the sales of micro-ovens. As there exists virtually no
correlation between the micro-ovens and widgets offered by the company, the pricing strategy
with respect to widgets can simply ignore the sales of micro-ovens.
It can be concluded that the demand of the widgets is highly sensitive to the pricing of
widgets and income of the people. But the demanded quantity is insensitive to competitor’s
pricing and highly insensitive to sale of micro-ovens and advertising expenses.
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 the elasticity of price is ‘negative’ and highly elastic, any reduction in the price will
lead to high rise in quantity of the widgets demanded. But it is important to note that revenue can
only be maximized if the elasticity quotient is equal to one. But in case of price elasticity, it is
little over one, implying that any reduction in price increases the quantity demanded and enhance
the net gain in sales until the elasticity reaches unity. Hence, it is suggested that the company’s
reduces the price, increases the sales and the revenues generated by increasing the 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 dollars.
A.
Plot the demand curve for the firm.
Keeping all the other variables constant, the demand function can be written as,
Q = -5200 - 42*P + 20*600 + 5.2*5500 + 0.2*10000 + 0.25*5000
Q = 38650 - 42P
Demand Curve
800
600
400
200
0
0
B.
10000
20000
30000
40000
Plot the corresponding supply curve on the same graph using the following
MC / supply function Q = -7909.89 + 79.0989P with the same prices.
Su[ply Curve
700
600
500
400
300
200
100
0
0
C.
10000
20000
30000
40000
50000
Determine the equilibrium price and quantity.
From both the demand and supply equations, it can be written as
38650-42P = -7209.89+79.0989P
38650+7209.89 = (79.0989+42) P
Hence, 121.0989P= 45859.89
Therefore, P = 378.6978
Putting P in either of the equations gives Q= 22744.6924
The equilibrium price is 378.70 cents and the equilibrium quantity is 22745 units.
DEMAND SUPPLY CURVE
45000
40000
35000
30000
25000
20000
15000
10000
5000
0
0
D.
100
200
300
400
500
600
700
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.
As indicated above, the demand for the widgets is highly sensitive to pricing of the
product and incomes of the consumer base or the target market. But the demand is
insensitive to pricing of the competitor’s products, advertising expenses and ale of micro
ovens. Some short-term changes in supply of the product can be attributed to if there is a
change in supplier network or due to some raw-material constraints or late arrival from
the manufacturing plant due to lack of labor etc., affecting the production costs. Some
long-term changes in demand and supply can be attributed to factors such as
technological advances; change is customer preferences due to some other good products
in the market etc.
Indicate the crucial factors that could cause rightward shifts and leftward shifts of the
demand and supply curves.
Right-ward shift in the demand curves can be attributed to some factors like rise in
consumer income and decrease in price of the complementary products like the micro oven. Leftward shift in demand curves can be attributed some factors like decrease in consumer income
and rising inflation or an increase in price of the complementary products.
. Right-ward shift in the supply curves can be attributed to factors like cheap labor,
reduced taxation, advanced technology leading to decreased production costs and abundance of
raw materials. Left-ward shift in supply curves can be related to increase in wages, high interest
rates and scarcity of resources or raw material.
References:
Braeutigam, Ronald (2010). Microeconomics (4th ed.). Wiley
Case, K.E., Fair, R.C. (1994). 'Demand, Supply, and Market Equilibrium', Chapter 4 in Principles
of Economics, 3rd ed., Prentice Hall Englewood Cliffs, New Jersey
Robert L. Vienneau. (Sep. 2005). "On Labour Demand and Equilibria of the Firm", Manchester
School, V. 73, N. 5: p.502