21 May WOULD SUCH A PRICE INCREASE HELP OR HURT TOBACCO INDUSTRY PROFITS?
5.4 :Following a price change for Diet Coke, explain how retailers use sales information to learn if Doritos snack chips represent a complement or substitute for Diet Coke.
Q5.8An estimated 80 percent increase in the retail price of cigarettes is necessary to cause a 30 percent drop in the number of cigarettes sold. Would such a price increase help or hurt tobacco industry profits? What would be the likely effect on industry profits if this price boost was simply caused by a $1.50 per pack increase in cigarette excise taxes?
Problems
P5.5 Elasticity.
The demand for personal computers can be characterized by the following point elasticities: price elasticity =—5, cross-price elasticity with software =—4, and income elasticity = 2.5. Indicate whether each of the following statements is true or false, and explain your answer.
A. A price reduction for personal computers will increase both the number of units demanded and the total revenue of sellers.
B. The cross-price elasticity indicates that a 5 percent reduction in the price of personal computers will cause a 20 percent increase in software demand.
C. Demand for personal computers is price elastic and computers are cyclical normal goods.
D. Falling software prices will increase revenues received by sellers of both computers and software.
E. A 2 percent price reduction would be necessary to overcome the effects of a 1 percent decline in income.
P5.6 Optimal Pricing.
In an effort to reduce excess end-of-the-model-year inventory, Harrison Ford offered a 1 percent discount off the average price of 4WD Escape Gas-Electric Hybrid SUVs sold during the month of August. Customer response was wildly enthusiastic, with unit sales rising by 10 percent over the previous month’s level.
A. Calculate the point price elasticity of demand for Harrison Ford 4WD Escape Gas-Electric Hybrid SUVs sold during the month of August.
B. Calculate the profit-maximizing price per unit if Harrison Ford has an average wholesale (invoice) cost of $23,500 and incurs marginal selling costs of $350 per unit.
P5.10 Advertising Elasticity.
Enchantment Cosmetics, Inc., offers a line of cosmetic and perfume products marketed through leading department stores. Product Manager Erica Kane recently raised the suggested retail price on a popular line of mascara products from $9 to
$12 following increases in the costs of labor and materials. Unfortunately, sales dropped sharply from 16,200 to 9,000 units per month. In an effort to regain lost sales, Enchantment ran a coupon promotion featuring $5 off the new regular price. Coupon printing and distribution costs totaled $500 per month and represented a substantial increase over the typical advertising budget of $3,250 per month. Despite these added costs, the promotion was judged to be a success, as it proved to be highly popular with consumers. In the period prior to expiration, coupons were used on 40 percent of all purchases and monthly sales rose to 15,000 units.
A. Calculate the arc price elasticity implied by the initial response to the Enchantment price increase.
B. Calculate the effective price reduction resulting from the coupon promotion.
C. In light of the price reduction associated with the coupon promotion and assuming no change in the price elasticity of demand, calculate Enchantment’s arc advertising elasticity.
D. Why might the true arc advertising elasticity differ from that calculated in part C?
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