Posted by klynn on Tuesday, October 16, 2007 at 12:50pm.
This is some HW for a Managerial Econ class. I've got what I think are the answers, and I'd just like someone to read over my reasoning & check my answers. Any assistance is appreciated. Thanks!
2.) A recent study of the Madison, Wisconsin market by Chemyellow, Inc. found that the local demand for weed obliteration and pest control services is described by the following elasticities: price elasticity = -1.5, cross-price elasticity with a local competitor offering the same services = 2.0, income elasticity = 5, TV advertising elasticity = 3. Indicate whether each of the following statements is true or false and explain your answer.
A. A price reduction of Chemyellow will increase both the number of units demanded and Chemyellow revenues.
Answer: True. Chemyellow's price elasticity is -1.5, which means Chemyellow has elastic demand. With elastic demand, a price change leads to a more than proportionate change in quantity demanded. Also, with elastic demand, a price decrease leads to an increase in revenues.
B. A 15% reduction in Chemyellow prices would lead to a 10% increase in unit sales.
Answer: False. Given that price elasticity is -1.5, a 1% decrease in price would lead to a 1.5% increase in quantity demanded. So, if Chemyellow implemented a 15% reduction in price, the quantity demanded would increase 22.5%. With elastic demand, a price change leads to a more than proportionate change in quantity demanded. So, if price is reduced by 15%, the resulting change in quantity demanded has to be higher than 15%.
C. The cross-price elasticity indicates that a 10% increase in Chemyellow prices would lead to a 20% increase in the sales of a local competitor.
Answer: True. The competitor's product is a substitute for Chemyellow's product, so there is a direct relation between the price of Chemyellow's product and the demand for the competitor's product. With substitutes, a price increase for a given product (in this case, Chemyellow's product) will increase demand for substitutes (in this case, the competitor's product). So, given that Chemyellow's cross-price elasticity with the competitor is 2.0, a 1% increase in Chemyellow prices would lead to a 2% increase in the demand for the competitor's product. So, a 10% increase in Chemyellow prices would lead to a 20% increase in the demand for the competitor's product.
D. The demand for Chemyellow services is price elastic and typical of noncyclical normal goods.
Answer: False. Although the demand for Chemyellow services is price elastic (price elasticity = -1.5), the demand is not typical of noncyclical normal goods. For a product to be considered a noncyclical normal good, the income elasticity has to fall between 0 and 1. Chemyellow's income elasticity is 5, so Chemyellow products would fall into the category of cyclical normal goods. Cyclical normal goods are goods with an income elasticity over 1. Cyclical normal goods are products for which demand is strongly affected by changing income.
E. A 4% increase in TV advertising would be necessary to increase the negative effect on Chemyellow sales caused by a 6% decrease in the prices of a local competitor.
Answer: True. First, we will consider the impact of the 6% decrease in the prices of a local competitor. Chemyellow's cross-price elasticity with the local competitor is 2.0, so a 1% decrease in the prices of a local competitor would lead to a 2% decrease in the demand for Chemyellow's products. So, if the competitor decreased its prices by 6%, the demand for Chemyellow's products would decrease by 12%. Now, we can consider the effect that a change in advertising has on Chemyellow demand. Chemyellow's TV advertising elasticity is positive (TV advertising elasticity = 3), so there is a direct relation between Chemyellow's TV advertising and demand for Chemyellow's products. Chemyellow's TV advertising elasticity is 3, so a 1% increase in Chemyellow's TV advertising will lead to a 3% increase in demand for Chemyellow's products. So, if Chemyellow's TV advertising is increased by 4%, the demand for Chemyellow's products would increase by 12%. In conclusion, the 6% decrease in price of a local competitor led to a 12% decrease in demand for Chemyellow products. However, if Chemyellow increases its TV advertising by 4%, the result would be a 12% increase in demand for Chemyellow products. So, in effect, the increase in demand caused by an increase TV advertising offsets the decrease in demand caused by the decrease in a local competitor's prices.
- Managerial Economics - economyst, Wednesday, October 17, 2007 at 4:40pm
I agree with all of your answers for A,B,C, and E.
For D, I must abstain. I have never seen the words "cyclical" and "noncyclical" to describe the income elasticities of goods. In my day, a good with an income elasticity greater than one was a superior good; less than one was an inferior good.
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