Module 3: Revision Exercise Number 4 - Applied Exercises

Question 1 - Applying the concept of elasticity to the operations of a supermarket The management of a suburban supermarket is not satisfied with the performance of the store. The management team wishes to increase both the level of sales and the total revenue of the supermarket. The supermarket sells 800 products and - for the purpose of simplicity - each product sells for $4 per unit. The management team divides these 800 products into 4 groups of 200 products and estimates that products in Group A have a price elasticity of 0.5; Products in Group B have a price elasticity of 1; Products in Group C have a price elasticity of 1.5 and products in Group D have a price elasticity of 2. This information, together with the quantity demanded and sales revenue of the store is summarised below.

Group A Products Group B Products Group C Products Group D Products Total

No. of products in group 200 200 200 200 800

Ed per product group 0.5 1 1.5 2

Price per product $ 4 4 4 4

Qty Demanded Per Week 62.500 25,000 37,500 25,000 150,000

Total Revenue Per Week 250,000 100,000 150,000 100,000 600,000

The above information indicates that this supermarket sells 150,000 products per week and has a total revenue of $600,000 per week. In order to increase both the level of sales and the total revenue of this store, the concept of price elasticity of demand is used by the management team. The management considers two proposals: 1. Reducing all prices by 10% 2. Increasing prices of Group A products by 10%. Not changing prices of Group B products and decreasing prices of Group C and D products by 10%. Use the above information to calculate how each of the above proposals would affect the supermarkets sales and total revenue. It is necessary to demonstrate your calculations in the following tables. 1

Proposal 1 No. of products in group 200 200 200 200 800 Ed per product group 0.5 1 1.5 2 New Price per product $ Qty Demanded Per Week Total Revenue Per Week

Group A Products Group B Products Group C Products Group D Products Total

Proposal 2

Group A Products Group B Products Group C Products Group D Products Total

No. of products in group 200 200 200 200 800

Ed per product group 0.5 1 1.5 2

New Price per product $

Qty Demanded Per Week

Total Revenue Per Week

Explain whether the management of this supermarket is likely to adopt Proposal 1or Proposal 2. Your answer should clearly explain why Proposal 1 or Proposal 2 is preferred and should demonstrate an understanding of the concept of price elasticity of demand.

Question 2 - Elasticity of demand and Government policy American studies of the automotive industry indicate that the demand for new passenger Vehicles have a price elasticity coefficient within the range of 1.2 - 1.5. For the purpose of this question it is assumed that the Australian car industry has similar levels of price elasticity of demand. The Australian car industry sells approximately 300,000 new passenger vehicles per year at an average price of $30,000 per vehicle. The Australian government places sales tax of 20% (approx) on each car. The final price of $30,000 therefore includes $6000 of sales tax. Assuming a price elasticity coefficient of 1.5 calculate: i. the total expenditure on new passenger motor vehicles if indirect taxes are not changed ii. total indirect tax collected by the government if indirect taxes are not changed. iii. the demand for passenger motor vehicles if government reduced indirect taxes from 20% to 10% iv. total expenditure on passenger motor vehicles if indirect taxes are reduced from 20% to 10% v. total indirect tax collected by government if indirect taxes are reduced from 20% to 10% vi. the net loss/gain of revenue to the government when indirect taxes are reduced from 20% to 10% Explain the economic conditions under which the government would reduce indirect taxes on passenger motor vehicles.

Question 3 Explain the likely cross elasticity of demand between the following products: (a) rice and noodles (b) electricity and electric stoves (c) paper bags, aluminium foil, plastic wrap

Question 4 Over a number of months Fineweave, a carpet manufacturer, was selling its carpet at $100 per square metre, with regular weekly sales of 1500 square metres. Then, due to a reduction in a competitors price from $105 to $95 per square metre, Fineweaves regular sales fall to 1250 square metres. Some time later there was an increase in real average weekly income from $400 to $410, and regular weekly sales of Fineweave carpet increased from 1250 to 1300 square metres. (a) Calculate and interpret the arc cross price elasticity of demand for Fineweave carpet. (b) Calculate and interpret the arc income elasticity of demand for Fineweave carpet. Do consumers view Fineweave carpet as a normal or an inferior good?

Question 5 A firm marketing cameras (Product A) has the following data regarding demand for product A. price elasticity of demand is -2.0 cross elasticity of demand with product B is +3.0 cross elasticity of demand with product C is -0.2 income elasticity of demand is +2.5

Explain the meaning of each of the above elasticity values and its significance for the sales of product A.