Assignment 2

Demand Estimation 0

Running head: DEMAND ESTIMATION

Demand Estimation

Rhonda Demory

Professor Dr. Camille Castorina

ECO 550 Managerial Economics & Globalization

April 24, 2017

Elasticities of each of the independent variable

According to Baumol & Blinder (2015), analysis of demand gives the marketing team of an entity insight, which enables forecasting of sales. This also helps to project revenue and cash flows, which in turn provides educated investment decisions. One of the common measures used to determine responsiveness of the quantity demanded or supplied depends on changes in non-price determinants of demand. Demand elasticity is arrived at by establishing the percentage change in quantity divided by percentage change in price. Following is a solution to the regression question in this case:

Regression Equation:

QD =   - 5200 - 42P + 20PX + 5.2I + .20A + .25M

Standard Errors: (2.002), (17.5), (6.2), (2.5), (0.09), (0.21), R2 = 0.55, n = 26, F = 4.88

QD      =   - 5200 - 42P + 20PX + 5.2I + .20A + .2

= -5200 – 42(500) + 20(600) + 5.2(5500) + .20(10000) + .25(5000)

= -5200-21000+12000+28600+2000+1250

= 17650

Therefore, quantity demanded = 17,650

Price Elasticity = (P/Q) (∆Q/∆P)

From the regression equation, ∆Q/∆P = -42

Thus, Price Elasticity (Ep) = (P/Q) (-42) (500/17650) = -1.19

Likewise,

Epx = 20(PX/Q) = 20(600/17650) =.68

EI = 5.2(I/Q) = 5.2(5,500/17650) = 1.62

EA = .25(A/Q) = .20(10,000/17650) = 0.11

EM = .25(M/Q) = .25(5000/17650) = 0.07

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

Every business aims at increasing revenues but businesses are always torn between raising prices or giving price discounts to increase sales. According to McGuigan, Moyer & Harris (2014), the law of demand states the higher a price is, the lower its demand will be while the lower the price of a product is, the higher the demand. Thus, to gauge the extent to which demand rises or decreases upon a price change, it is important for a company to conduct an analysis of elasticity of demand. In this case, the enterprise needs to understand the level of sensitivity of its consumers upon change in price of the product.

Price Elasticity of demand is calculated by dividing the percentage change in price by the percentage change in quantity. The resultant quotient enables decision makers to analyze how elastic or inelastic the price is in relation to percentage change in the price as well as the amount demanded. When the demand elasticity is less than 1 (absolute value), the demand elasticity is inelastic. This means that consumers do not exhibit sensitivity to price changes but when it is greater than 1 (absolute values), the consumers respond significantly to a change in prices.
In this case the price elasticity is:

Ep = -42(P/Q) = -42(500/17650) = -1.19

This means that the elasticity is elastic and the entity’s customers are thus sensitive to price changes. I this case, raising the price by 1%would result in a 1.19% decrease in demand while giving a 1% price discount would increase quantity demanded by 1.19%.

For the competition;

Epx = 20(PX/Q) = 20(600/17650) =0.68

The product is inelastic to some extent to competitor’s price. A 1% increase in the price of competitor product would result in a 0.68 increase in demand for this firm’s products and vice versa. A change in competitor prices has an insignificant effect on the demand of the firm’s product.

For the statistical area income;

EI = 5.2(I/Q) = 5.2(5,500/17650) = 1.62

This demand elasticity is elastic meaning 1% increase in average income of people in this area would result in 1.62% increase in quantity demanded. Thus, the firm can decide to raise its price if the average income of consumers in the area rises.

For advertising and microwaves;

EA = .25(A/Q) = .20(10,000/17650) = 0.11

EA = .25(A/Q) = .20(10,000/17650) = 0.07

For the two their demand elasticity is less than 1 (absolute value) meaning their variation does not have a significant effect on the quantity of the entity’s products demanded. Increasing advertisement cost by 1% leads to 0.11% increase in demand. If the company were to transfer advertisement costs to consumers by increasing prices, demand would decrease. For the quantity of microwaves in the area, a 15 increase in their number affects demand by only 0.07% hence microwaves can be overlooked in the firm’s pricing strategy.

Recommendation to the firm about cutting its price to increase its market share

Since the price elasticity of the firm is 1.19 (absolute value), the firm should issue a price discount for its products. A discount will lead to an increase in demand for the firm’s product, which would in turn increase revenues for the entity. Issuing a price discount is also beneficial considering the determinant of income as the income elasticity is elastic which means that the level of income affects the quantity demanded. The situation is such that their income level influences their price sensitivity. This is a good economic indicator that the firm should decrease its price. Due to their tight income, consumers will increase the amount demanded upon reduction of the price (Nelson, 2013).

Demand and Supply curve for the firm.

Equilibrium price and quantity

The equilibrium price and quantity figures are at the point where the supply and demand curves intersect. From the above graph, the two intersect i.e. (22,501.6, 384.48). This means the equilibrium price is 384.48 cents and the equilibrium quantity demanded is 22,501.6 units. The same can be obtained from solving the demand curve;

Q = -5200 - 42(P) + 20(600) +5.2(5500) +0.2(10,000) +0.25(5000)

Q = 38,650 – 42P

P = 38,650/42-Q/42

Q = 5200 =45P

P = - 5200/45 + Q/45

By solving the two curves:

38,650 - 42P = 5200 + 45P

87P = 33,450

P = 384.48

Q = 5200 + 45(384.48)

Q = 22,501.6

Factors that could cause changes in supply and demand for the low-calorie, frozen microwavable food

In the short-run, the most significant factors that cause changes in demand and supply for the low-calorie, frozen microwavable food is a change in the prices of the product or a change in the level of income of consumers. The price is the most significant. One factor is the price of the low-calorie, frozen microwavable food itself. Consumers are already used to buying the product at a certain price. An increase in the general price of the product will see them shift to substitute products. The opposite is true in case of a reduction in price (Pettinger, 2012). For example, a reduction of the price from 500 cents to 200 cents increases quantity demanded to 28,400 units.

An increase in the level of income of consumers would also result in an increase in demand provided other factors are held constant. A decrease in price and decrease in the level of income would result in a decrease quantity demanded. In the long-run, entry of other competitors would give consumers more options leading to less demand (Baumol & Blinder, 2015). 

For supply, a decrease in market prices for low-calorie, frozen microwavable products would render it unattractive for the firm forcing it to reduce supply in the short-term. In the long-term, many competitors may enter the market with lower prices, which would also make the market unattractive for the company. This would force the company to lower prices and increase supply or maintain the prices but reduce supply due to the resultant lower demand (Baumol & Blinder, 2015). 

Factors that could cause rightward shifts and leftward shifts of the demand and supply curves for the low-calorie, frozen microwavable food

According to McGuigan, Moyer & Harris (2014), many factors can cause a rightward shift and leftward shifts in the supply and demand curves of this firm. Rightward shifts may be due to an increase in the income level of consumers, reduced price of complimentary products such as microwave ovens and a heightened product preference due to increased sensitization on benefits of consuming low-calorie diets. A leftward shift in the demand curve may be due to economic factors such as a recession, reduced consumer income and an increase in the price of complimentary products.

For the supply curve, a rightward shift may be due to technological improvement in the processing of such foodstuffs resulting in economies of scale from the ability to produce more quantity at a certain price. In addition, increased availability of cheap labor, raw materials, government subsidies and tax-cuts also results in a rightward shift. Entry of competitors would also see the curve shift right as the general supply of the product would increase. A leftward shift may be due to reduced availability of raw materials or high prices of the same, expensive labor and increased government taxes. These make cost of production higher forcing firms to reduce production and thus supply of the products (Pettinger, 2012).

References

Baumol, W. J., & Blinder, A. S. (2015). Microeconomics: Principles and policy. Cengage Learning.

McGuigan, J. R., Moyer, R. C., & Harris, F. H. (2014). Managerial economics: applications, strategies and tactics (13th ed.). Stamford, CT: Cengage Learning.

Nelson, R. (2013). Demand, supply, and their interaction on markets, as seen from the perspective of evolutionary economic theory. Journal of Evolutionary Economics, 23(1), 17-38. doi:10.1007/s00191-012-0274-4.

Pettinger, T. (2012). Understanding Elasticity. Retrieved April 17, 2017, from http://www.economicshelp.org/blog/301/concepts/understanding-elasticity/