CASE STUDY 1 ABC Enterprise is considering increasing the price of its product, currently Rs.20, by 25%.

ABCs current revenue is Rs.12,000 a month, and the Price Elasticity of Demand for its product is estimated to be -1.8. a) Calculate the effect of the price change on ABCs revenue. b) ABC now considers increasing its advertising budget to restore its sales revenue to its previous level. ABC is currently spending Rs.1500 a month on advertising and estimates its Advertising Elasticity of Demand to be 1.5. What will its new budget have to be?

Solution a) Q = 12,000/20 = 600 P = 20 P = 25 PED = Q P1 + P2 P Q + Q

1 1 1 2

-1.8 = Q2 600 (20 + 25) 5 600 + Q

2 2

-1.8 (600 + Q ) = (Q 600)9 -1080 1.8Q = 9Q 5400

2 2

-10.8Q = -4320
2

Q = 400
2

R = 25 400 = Rs.10,000
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b) Q = 400 Q = 12,000/25 = 480 A = 1500 AED = Q A1 + A2 A Q + Q

1 2 1 2 1

1.5 = 480 - 400 1500 + A2 A - 1500 400 + 480 1.5(A 1500)(11) = 1500 + A 16.5A 24,750 = 1500 + A
2 2 2 2 2 2

15.5A = 26,250 A = Rs. 1694 a month

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CASE STUDY 2

KR Corp, an appliance firm, is currently selling 800 lamps per month. Its total costs are Rs. 24,000 per month, and its unit variable costs are Rs. 20, rising by Rs. 2 for every additional hundred units produced. It is currently charging a price of Rs. 40, but this has recently been reduced from Rs. 45, because sales were only reaching 750 units per month.

a) Derive the cost and revenue functions for the firm. b) Calculate the price elasticity of demand at the current price. c) Calculate the profit-maximizing price and output. d) Calculate the amount of profit that the firm is currently foregoing.

SOLUTION a) Q = a + bP Where a is constant and b is change in quantity due to change in price b = 50/-5 = -10 (Change in Quantity due to change in Price. To have a 50 units increase in quantity there should be Rs. 5 decrease in Price) 800 = a 10(40) a = 1200 Q = 1200 - 10P TC = 24,000, VC = 20(800) = 16,000, FC = 24,000 16,000 = 8,000 AVC = a + bQ where a is constant and b is change in VC due to change in quantity. b = 2/100 = 0.02 20 = a + 0.02(800) a=4 AVC = 4 + 0.02Q
2

VC =AVC X Q = (4 +0 .02Q)Q = 4Q + 0.02Q

2

TC = 16,000 + 4Q + 0.02Q b) PED = -10(40/800) = - 0.5

c) TC = 16000 + 4Q + 0.02Q2 TC/Q = 4 + 0.04Q Therefore MC = 4 + 0.04Q

P = a bQ where a is constant and b is effect of change in price on quantity b = 5/50 = 0.1 change in price by Rs.5 there will be 50 units change in quantity. 40 = a - 0.1(800) = a 80 a = 120 P = 120 0.1Q Revenue (TR) = P X Q = (120 0.1Q) Q = 120Q 0.1Q TR/Q (MR) = 120 0.2Q Profit maximizing price and output occurs at equilibrium condition. Equilibrium condition is MC = MR Therefore 4 + 0.04Q = 120 0.2Q 0.24Q = 116 Q = 116/0.24 Q = 483 P = 120 0.1(483) = Rs.72
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d) Current profit = TR TC = 40(800) 24,000 = Rs. 8000 Maximum profit = 72(483) [16,000 + 4(483) + 0.02(483) ] = Rs. 12,178 Foregone profit = Rs. 4178 per month
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