discuss the following questions about elasticity measures:
1-) The short-run price elasticity of demand for oil is 0.3. If new discoveries of oil increase the quantity of oil by 6 percent, what will be the resulting change in the price of oil?
2-) As a brand manager for Honey Bunches of Oats cereal, you propose lowering the price by 4 percent. What will you tell your supervisor about what you expect will be the impact on sales in the short run and in the long run? Please explain your answer when answering to make it easier to assume that your competitors do not change their prices.
Full Answer Section
- Solve for the final price (P2):
P2 = (Q2 / D2) = (1.06Q1) / (1.018D1) = 1.04P1
Therefore, the price of oil will increase by 4% (1.04 - 1) due to the new oil discoveries.
2) Honey Bunches of Oats Price Change and Sales Impact
Assumptions:
- Price decrease is 4%.
- Competitors' prices remain constant.
Short-run impact:
- Increase in sales: A 4% price decrease makes Honey Bunches of Oats more attractive compared to rivals, leading to a shift in consumer preference and potentially boosting sales in the short run.
- Magnitude of increase: The increase in sales depends on several factors like brand loyalty, price sensitivity of consumers, product differentiation, and marketing efforts. Estimates suggest a potential sales increase of 5-10% in the short run.
Long-run impact:
- Potential price war: Competitor response is crucial. If they match the price drop, profitability can suffer for all, leading to a price war scenario.
- Reduced profit margins: Lower prices directly impact profit margins, even if sales increase.
- Market positioning: Long-term brand positioning should be considered. Frequent price cuts can hurt the brand image and perceived value.
- Alternative strategies: Consider other promotional strategies like targeted discounts, loyalty programs, or product differentiation to avoid relying solely on price reduction.
Overall, a 4% price decrease can be an effective short-term tactic to boost sales. However, carefully consider the potential long-term implications and competitor response to ensure sustainable success.
Additional notes:
- The price elasticity of demand for Honey Bunches of Oats would be helpful to accurately predict the sales increase.
- The impact on different consumer segments should be analyzed for targeted promotion strategies.
Sample Answer
) Oil Price Change due to Increased Supply
Assumptions:
- Price elasticity of demand for oil is -0.3 (negative because demand decreases with increasing price).
- Increase in quantity of oil is 6%.
Solution:
- Calculate the percentage change in demand due to the price change:
Percent change in demand = Price elasticity of demand * Percent change in price
Since quantity and price are inversely proportional, a 6% increase in quantity translates to a -6% change in price (decrease). Therefore:
Percent change in demand = -0.3 * (-6) = 1.8%
- Set the equation for equilibrium at both initial and final states:
Initial: Q1 = D1 (where Q1 is initial quantity, D1 is initial demand) Final: Q2 = 1.06Q1 (new quantity with 6% increase) = 1.018D1 (new demand with 1.8% increase)