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

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 2.5 1 1. 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. 2 . of products in group 200 200 200 200 800 Ed per product group 0.Proposal 1 No.5 1 1. of products in group 200 200 200 200 800 Ed per product group 0.5 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.

The Australian government places sales tax of 20% (approx) on each car. aluminium foil. The Australian car industry sells approximately 300.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 1.000 therefore includes $6000 of sales tax. the total expenditure on new passenger motor vehicles if indirect taxes are not changed ii.000 per vehicle.2 .Question 2 . total indirect tax collected by government if indirect taxes are reduced from 20% to 10% vi. iii. plastic wrap 3 . 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.000 new passenger vehicles per year at an average price of $30.5. Assuming a price elasticity coefficient of 1. 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. total indirect tax collected by the government if indirect taxes are not changed. total expenditure on passenger motor vehicles if indirect taxes are reduced from 20% to 10% v.1. the demand for passenger motor vehicles if government reduced indirect taxes from 20% to 10% iv. For the purpose of this question it is assumed that the Australian car industry has similar levels of price elasticity of demand. The final price of $30.5 calculate: i.

5 Explain the meaning of each of the above elasticity values and its significance for the sales of product A.0 cross elasticity of demand with product B is +3. Then. • • • • price elasticity of demand is -2. due to a reduction in a competitor’s price from $105 to $95 per square metre. 4 .2 income elasticity of demand is +2.Question 4 Over a number of months Fineweave. with regular weekly sales of 1500 square metres. was selling its carpet at $100 per square metre. (a) Calculate and interpret the arc cross price 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. Fineweave’s regular sales fall to 1250 square metres. (b) Calculate and interpret the arc income elasticity of demand for Fineweave carpet.0 cross elasticity of demand with product C is -0. 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 carpet manufacturer.