Economic Assignment : Long-Term Investment Decisions

Have you ever wondered why demand and supply are at the heart of marketing? Decisions made by managers are crucial to the success or failure of a business. Roles played by business managers are becoming increasingly more challenging as complexity in the business world grows. Business decisions are increasingly dependent on constraints imposed from outside the economy in which a particular business is based both in terms of production of goods as well as the markets for the goods produced. The impact of rapid technological change on innovation in products and processes, as well as in marketing and sales techniques, figures prominently among the factors contributing to the increasing complexity of the business environment. Moreover because of increased globalization of the marketplace, there is more volatility in both input and product prices. The continuous changes in the economic and business environment make it ever more difficult to accurately evaluate the outcome of a business decision. In such a changing environment, sound economic analysis becomes all the more important as a basis of decision making.

According to McGuigan (2014) some key factors that will affect demand and supply of a good or service are five main demand factors are the number of buyers in a market, their average income, the prices of other products, consumer preferences, and consumer expectations about future prices and incomes. The difference between changes in demand and changes in the quantity demand is that quality demand refers to the response to changes in the price of commodities and change in demand refers to the change in demand caused by non-monetary influences.

Equation

QD = 20,000 - 10P + 1500A + 5PX + 10 I

(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, (P, A, PX, and I), in the equation. Assume the following values for the independent variables:

Q D = Quantity demanded

P (in cents) per case = Price of the product = 8000

PX (in cents) = Price of leading competitor’s product = 9000

I (in dollars) = Per capita income of the standard metropolitan statistical area (SMSA) where the supermarkets are located = 5000

A (in dollars) = Monthly advertising expenditures = 64

1. Compute the elasticity for each independent variable. Note: Write down all of your calculations.

When P = 8000, A = 64, PX = 9000, I = 5000, using regression equation,

QD = 20000 - 10*8000 + 1500*64 + 5*9000 + 10*5000 = 131,000

Price elasticity = (P/Q)*(dQ/dP)

From regression equation, dQ/dP = -10.

So, price elasticity EP= (P/Q) * (-10) = (-10) * (8000 / 131000) = -0.61

Similarly,

EA = 1500 * 64 / 131000 = 0.73

EPX = 5 * 9000 / 131000 = 0.34

EI ¬= 10* 5000 / 131000 = 0.38

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.

According to McGuigan (2014), when demand elasticity is less than 1 in absolute value, an increase (decrease) in price will result in an increase (decrease) in (P.Qd). The price elasticity is -0.61 which means a 1% increase in price of the product causes quantity demanded to drop by 0.61%. So, the demand of the product is relatively inelastic. Therefore, increase in price may not have large impact on the customers. Advertisement elasticity is 0.73, meaning 1% increase in advertising expenses increases quantity demanded by only 0.73%. So, demand is relatively inelastic to advertising. Therefore, more advertisement won’t necessarily mean that firm can raise the price because it still could drive customers away. Cross-price elasticity is 0.34 which means if price of competitor product increases by 1%, then quantity demanded of this product increases by 0.34%. So, product is relatively inelastic to competitor’s price and the firm shouldn’t worry about the competitor as their pricing won’t have any major effect on its own sales. Income-elasticity is 0.38 which means 1% rise in average income in the area boosts quantity demanded by 0.38%. So, product is relatively inelastic in this aspect and so the firm shouldn’t worry about consumer income considerations in pricing strategy. Quantity demanded won’t suffer largely from this aspect even if income increases/decreases. Therefore, quantity demanded is relatively inelastic to all factors considered.

The company should not have any concerns about these factors. Costs associated with being overly cautious about opening to capital flows. These costs include lower international trade, higher investment costs for firms, poorer economic incentives, and additional administrative/monitoring costs. Opening up to foreign investment may encourage changes in the domestic economy that eliminate these distortions and help foster growth (IMF, 2008).

3. Recommend whether you believe that this firm should or should not cut its price to increase its market share. Provide support for your recommendation.

A price slash would increase quantity demanded, as the price elasticity is negative. But, magnitude of elasticity is a less than unity. Revenue is maximized when the magnitude of elasticity is one. Therefore, a price-cut will increase quantity demanded but will lead to a loss of sales. So, price-cut should be made only if firm is trying to strengthen its consumer base; from profit perspective, it should instead raise the price (Wernerfel, 2002).

4. 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.

1. Plot the demand curve for the firm. Keeping other factors constant, demand equation is

Q = 20000 - 10*8000 + 1500*64 + 5*9000 + 10*5000

Q = 211000 - 10P

P = 21100 - 0.1Q (plotted below)

2. Plot the corresponding supply curve on the same graph using the supply function Q = 5200 + 45P with the same prices.

Q = 5200 + 45P

P = -5200/45 + Q/45

3. Determine the equilibrium price and quantity. Solving demand and supply equation simultaneously,

211000 - 10P = 5200 + 45P

55P = 211000 - 5200

P = 3741.82

and Q = 5200 + 45*3741.82 = 173,581

Therefore the equilibrium price is 3742 cents and equilibrium quantity is 173,581 units. The equilibrium price and quantity can also be found from the graph to be the point where supply and demand curve intersect.

4. 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 the demand equation points out, demand of the low-calorie food can change due to a change in consumer income, price of competitor product and price of related goods (microwave oven). The change can also come as a result of change in consumer preference (like awareness towards low-calorie food). Supply of the product can change due to change in number of suppliers of the product, technological advances in the production and other factors like change in availability of labor and raw-material which directly affect production costs.

5. Indicate the crucial factors that could cause rightward shifts and leftward shifts of the demand and supply curves.

According to Whelan (1996), demand is the rate at which consumers want to buy a product. Economic theory holds that demand consists of two factors: taste and ability to buy. Taste, which is the desire for a good, determines the willingness to buy the good at a specific price. Ability to buy means that to buy a good at specific price, an individual must possess sufficient wealth or income. Whenever there is a change in one of the factors of either supply or demand, market equilibrium will be affected. The aggregate demand curve also can shift right as the economy expands. When the aggregate demand curve shifts right, the quantity of output demanded for a given price level rises. Therefore, a shift of the aggregate demand curve to the right represents an economic expansion. A rightward shift of demand curve could be caused by an increase in consumer income, a decrease in price of complementary product like microwave ovens, an increase in population or increased preference for the product like awareness towards low-calorie food. A leftward shift of demand curve can be caused by a drop in consumer income or recession, increase in price of complementary product like microwave oven etc.

A rightward shift of supply curve can be caused by technology advances in food processing, increased availability of cheap labor and raw material, increased tax-cuts and government subsidies etc. A leftward shift can be caused due to a decrease in availability / increase in price of labor and raw materials, increased taxes etc. There are many actions that will cause the aggregate demand curve to shift. When the aggregate demand curve shifts to the left, the total quantity of goods and services demanded at any given price level falls.

Conclusion

In conclusion, the demand for a particular product by an individual consumer is based on four important factors. First, the price of the product determines how much of the product the consumer buys, given that all other factors remain unchanged. In general, the lower the product's price the more a consumer buys. Second, the consumer's income also determines how much of the product the consumer is able to buy, given that all other factors remain constant. In general, a consumer buys more of a commodity the greater is his or her income. Third, prices of related products are also important in determining the consumer's demand for the product. Finally, consumer tastes and preferences also affect consumer demand. The total of all consumer demands yields the market demand for a particular commodity; the market demand curve shows quantities of the commodity demanded at different prices, given all other factors. As price increases, quantity demanded falls. Individual consumer demands thus provide the basis for the market demand for a product. The market demand plays a crucial role in shaping decisions made by firms. Most important of all, it helps in determining the market price of the product under consideration which, in turn, forms the basis for profits for the firm producing that product.

References

IMF. (2008). Globalization: A Brief Overview. Retrieved January 19, 2014 from Academic

Search Premier database.

McGuigan, J. R., Moyer, R. C., & Harris, F. H. deB. (2014). Managerial economics:

applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning

Wernerfel, B. (2002). The Relation Between Market Share and Profitability. The Journal of

Business Strategy. Retrieved January 19, 2014 from Academic Search Premier database.

Whelan, J. (1996). Economic Supply and Demand. Retrieved January 19, 2014 from Academic

Search Premier database