Demand Estimation
Due Week 3 and worth 200 points
Answers
The maker of a leading brand of low-calorie microwavable food estimates the following demand equation for its product using data from 26 supermarkets around the country for the month of April.
Q = - 5200 - 42P + 20PX + 5.2I + .20A + .25M
(2.002) (17.5) (6.2) (2.5) (0.09) (0.21)
R2 = 0.55 n = 26 F = 4.88
Assume the following values for the independent variables:
Q = Quantity sold per month
P (in cents) = Price of the product = 500
PX (in cents) = Price of leading competitor’s product = 600
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
Using this information, answer the following questions:
1. Compute elasticities for each variable.
Solution:
Q = - 5200 - 42P + 20PX + 5.2I + .20A + .25M
= - 5200 - 42(500) + 20(600) + 5.2(5500) + .20(10,000) + .25(5000)
= - 5200 - 21000 + 12000 + 28,600 + 2000 + 1250
Q = 17,650
a. EP = - 42 * 500 = -1.18
17,650
EX = 20 * 600 = .68
17,650
EI = 5.2 * 5,500 = 1.62
17,650
EA = .20 * 10,000 = .113
17,650
EM = .25 * 5,000 = .07
17,650
2. 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.
Answer:
The demand is slightly price elastic (the elasticity coefficient is bigger than the absolute value of 1). This means that consumers are responsive to price changes. Therefore, if the firm wants to increase its revenue, it should lower its price.
Cross elasticity is positive, implying that the products are substitutes, but it is less than 1, suggesting that they are not particularly good substitutes and the competitor’s price has little impact on the firm’s sales.
The product is income elastic. The income elasticity coefficient is bigger than 1. This implies that the product the firm produces is a superior good (a luxury good) and is reponsive to income fluctuations. This firm should be very concerned if the economy slows down because disposable income decreases.
Advertising elasticity is smaller than 1. The product is inelastic with respect to advertising; a 1 % increase in advertising expense will lead to a 0.113 % increase in sales. Thus, advertising does not have a significant effect on sales.
The elasticity coefficient of .07 suggests that a 1 % change in the price of microwave ovens will change the sales of the firm by only 0.07 %.
3. Do you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.
Answer: This firm might want to cut its price to increase its sales because the product is price elastic (although only barely). However, if its leading competitor retaliates, the firm must expect to be affect substantially because its cross price elasticity is relatively high.
4. Assume that all the factors affecting demand in this model remain the same, but 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.
b. Plot the corresponding supply curve on the same graph using the supply function Q = 5200 + 45P with the same prices.
c. Determine the equilibrium price and quantity.
Answer: Please refer to the Excel file for the supply and demand graph.
d. 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 long-term changes in the market conditions could impact the demand and the supply of the product.
Answer:
Consider factors affecting the demand such as price of related goods (substitutes and complements), consumer tastes and preferences, advertising, number of consumers, expectations of future prices, etc.
Consider factors affecting the supply such as price of inputs, technology, number of suppliers, expectation of future prices, taxes or subsidies, etc.
Answers will vary.
5. Indicate the crucial factors that could cause rightward shifts and leftward shifts of the demand and supply curve.
Answer: Identify the most important factors affecting the demand and supply of low-calorie microwavable food.
Answers will vary.
6. Use at least three (3) quality academic resources in this assignment. Note: Wikipedia does not qualify as an academic respurce.
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