Assignment 2: Operations Decision

Running Head: DEMAND ESTIMATION 1

DEMAND ESTIMATION 2

Question1

Compute the elasticities of each independent variable.

Option 1

QD = - 5,200 - 42P + 20PX + 5.2I + 0.20A + 0.25M

QD = -5200 – 42(500) + 20(600) +5.2(5,500) + 0.20(10,000) + 0.25(5,000)

= 17,650.

Using the standard errors, QD2 = -5202 – 59.5P +26.2PX + 7.7I + 0.29A + 0.46M

QD2 = -5202 – 59.5(500) +26.2(600) + 7.7(5,500) + 0.29(10,000) + 0.46(5,000)

= 28,318.

Therefore, elasticity of demand = Δ Qd/Q1X Δ P/P1 = 10,668/17,650 X 8,750/21,000

ED = 0.25.

Note that elasticity of demand is the responsiveness of demand given a change in the price of a commodity. A ratio of greater than 1 means that the product is highly responsive with a slight change in the price.

Option 2

QD = -2,000 - 100P + 15A + 25PX +10I

QD= -2,000 – 100(200) + 15(640) + 25(300) + 10(5,000)

= 63,100

Incorporating standard errors, QD1 = -7,234 – 102.29P + 540A + 26.75PX + 11.5I

QD1 = -7,234 – 102.29(200) + 540(640) + 26.75(300) + 11.5(5,000)

= 383,433

ED = Δ Qd/Q1X Δ P/P1 = 320,333/63100X458/20,000 = 0.12

Question 2

Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies.

Basically, the price elasticity of demand refers to the degree of change in the demand of a given commodity with a change in price of the same product. The interpretation of elasticity is that price elastic of greater than 1 means that such a product is highly responsive to the change in price. In this case, a slight change in the price of the product will result to a substantial change in the quantity demand at a given point in time. On the other hand, elasticities with a negative sign mean that the product is inelastic. In other words a slight change in the price of such a commodity has no impact in the quantity demand. An example of such a product includes salt or durable commodities like wheelbarrows. In this scenario, the product is relatively responsive to price since its elasticity is less than 1 in both options. However, option 1 has a higher elasticity compared to the second option. Therefore, the management of the company that sells microwaves should not consider changing their pricing both in the long and short term since there will be no great impact in the quantity demanded.

Question 3

Recommend whether you believe that this firm should or should not cut its price to increase its market share

The decision as whether the firm should cut or not cut its price solely relies on the aforementioned elasticities. Thus, depending on the value of the computed price elasticity of demand, the firm can comfortably make it pricing decisions. In this case, the price elasticity of demand is less than 1, where in option 1 it is 0.25 and 0.12 in option 2. Consequently, it is advisable for the firm not to consider altering its prices in order to gain the market share. This is because, the PED of its product are less than 1 and therefore there will be no huge effect in price change (Athukorala & Khan, 2016). Hence, it should continue charging the same price unless the market forces of demand and supply pushes the price above the equilibrium.

Question 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.

A) Plot the demand curve for the firm

B) Plot the corresponding supply curve on the same graph using the following MC / supply function Q = -7909.89 + 79.1P with the same prices.

a) The equilibrium price and quantity is $400 and 22,000 respectively.

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.

Factors that causes changes in demand

I. Increase in price of the product

II. Increase in government subsidy

III. Anticipation of future shortages

Factors that causes changes in supply

I. Future increase in the price of the product

II. Reduction in the price of inputs

III. Reduction in government policies and legislation

In addition, changes in the market conditions of the markets such as increase in the exchange and interest rates are likely to impact on the demand and supply of the product. For instance, a reduction is such rates will not be motivating to the suppliers since the market forces will push prices downwards leaving supplier with little to compensate for their efforts (Ehrenberg & Smith, 2016). However, on the demand for the same product will increase rapidly in the short run and may result to a shortage in the long run. This is because, suppliers reluctant to produce more in order to meet the rising escalating demand.

Question 5

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.

Factors that cause the demand curve to shift leftwards.

I. Increase in the price of the product. Theoretically, the law of demand states that, when prices increase, the quantity demanded decreases and the vice versa is true. Therefore, an increase in the price of a commodity will cause a decrease in the demand hence a shift to the left.

II. Government health warning. If the government publishes a report against the consumption of the product based on health grounds, consumers will stop buying the product and this is likely to reduce the demand of the product hence a shift to the left.

III. A negative product review by consumers can also reduce the demand and cause the curve to shift leftwards. For instance, if reports against the product based on quality flood the market, consumers may view the product negatively and stop future purchase.

IV. Reduction in the price of the substitute. If the price of a substitute is lower than that of the normal product, consumers may opt to shift and purchase a cheaper product with the same utility. The result will be a reduction in demand of the previous product causing the demand curve to shift left wards.

Factors that cause the demand curve to shift rightwards.

I. Reduction in the price of the product. If consumers notices that the price of the product reduces, they will purchase more of that commodity causing an increase in demand. The impact is a shift of demand curve to the right.

II. Changes in the price of a substitute. In the price of a substitute product reduces relative to the current product, consumers will starting buying the substitute good causing its demand to increase hence, shift to the right (De Grauwe, 2016).

III. Quality and technological improvement. If buyers discovers that the product quality has increased due to changes in technology, they will start buying the product. The impact is an increase in its demand causing the curve to shift right.

IV. Future expectations of shortages in microwave food. If consumers notices signs of future shortages, they will buy more of the product now in order to avoid scarcity in future. In the process, they will cause an increase in the demand of the product hence a shift of the demand to the right.

Factors that cause the supply curve to shift leftwards

I. Increase in production costs. If the cost of input associated with the production of the product increase, producers will face rising costs in the product of one unit of the product causing a decrease in the supply. Therefore, the supply curve will move inwards or simply shift to the left.

II. Decrease in the market price of that product. If the market offers a lower price for the product, suppliers will be unwilling to respond. This will cause a decrease in the supply of the microwave food resulting to a shift of the supply curve to the left (De Grauwe, 2016).

III. Government taxes. Taxes have the impact of increase the overall product cost and making production expensive. An increase in taxes therefore reduces supply and causes the curve to shift leftwards.

Factors that cause the supply curve to shift rightwards

I. Improvement in technology. If technology improves and favors the production of more microwave food, supply will increase causing the curve to shift outwards to the right.

II. Decline in the cost of production. If production costs reduces, the overall output will increase since producers will utilize need little funds to product significantly higher proportional output causing the curve to shift to the right.

III. Government subsidy. Increase or introduction of subsidies by the government will reduce the cost of inputs used in production. The effect is that it will cost producers less to produce more of the same product. Thus, the supply curve will shift towards the right.

References

Athukorala, P. C., & Khan, F. (2016). Global production sharing and the measurement of price elasticity in international trade. Economics Letters,139, 27-30.

De Grauwe, P. (2016). Economics of monetary union. Oxford university press

Ehrenberg, R. G., & Smith, R. S. (2016). Modern labor economics: Theory and public policy. Routledge.

Demand curve

Price 100 200 300 400 500 600 Quantity -9400 -13600 -17800 -22000 -26200 -30400

Demand and supply

Price 100 200 300 400 500 600 Demand -9400 -13600 -17800 -22000 -26200 -30400 Supply 0.11 7910.11 15820.11 23730.11 31640.11 39550.11