Elasticity and the Behaviour of Firms - Assignment Example

Elasti and the Behaviour of Firms 1. The change in price is – 5% and the change in the quantity demanded is 2%. Since elasti of demand is defined as the percentage change in quantity demanded divided by the percentage change in price: 1.2 - 5 = - 0.24 Thus the demand for this good is inelastic (i.e. price inelastic), because the price for the good has decreased by 5% but the quantity demanded has increased by only 1.2%. 1.2. The change in demand is -21% and the change in price is + 42%. According to the above formula, - 21 divided by + 42 is equal to - 0.5. Thus demand for this good is also inelastic. 1.3. The price increases from £190 to £228 and the demand falls from 156 units to 73 units. Thus: £38 divided by £190 and multiplied by 100 is equal to 20% (i.e. the price increase) while 83 divided by 156 and multiplied 100 is equal to -50%. Therefore -50 divided by +20 is equal to -2.5%. Demand is elastic. 1.4. Demand increases from 700 units to 735 units following a reduction in price from £123.80 to £94.26. Thus: the percentage change in demand is equal to 5% (35 divided by 700 and multiplied by 100), while the percentage change in price is equal to approximately -23% (£28.54 divided by £123.80 and multiplied by 100). Therefore the demand is inelastic. 1.5. The price of ‘Day Rider’ bus ticket is increased from £ 1.50 to £ 1.65 and public transport is known to have a Price Elasticity of Demand of -0.75. If 15,000 ‘Day Rider’ tickets were purchased every day before the price change how many will be purchased after the change Since -0.75 is the ultimate result of the working out of the percentages, multiplying the original ticket sales of 15, 000 by -0.75 we get the answer, i.e. 11,250. 2.1. A 2.9% increase in income leads to a 3.1% increase in the quantity demanded. 3.1% divided by 2.9% is equal to approximately +1.07. This good must be a normal good because an increase in income causes the demand to rise. Examples include education and health care services. 2.2. An increase in average income levels from £20,800 to £22,120 leads to a changes in the level of demand for a good from 180,000 units per month to 195,000 units per month. The percentage change in income is equal to approximately 6.34% while the change in the quantity demanded is equal to approximately 8.33%. Thus the income elasticity of demand for the good is approximately 1.31%. The good again must be a normal good. 2.3. A decrease in the price of Millen’s crisps (potato chips) of 8% leads to a fall in the level of demand for McDermmot’s Spicy Dippers of 5.9%. When the percentage change in demand is divided by the percentage change in price (i.e. -5.9% by -8%) the answer is approximately 0.74%. Millen’s crisps must be a close substitute for McDdermmot’s Spicy Dippers. This is an example of cross elasticity of demand (Fox, Johnson, Sengupta & Thorbecke, 1992). 2.4. The average price of winter holidays increases from £ 288.14 to £ 412.53 over a three year period. During the same period the number of snowboards sold in the UK decreases from 4,860 to 4, 131. The price increase for winter holidays is approximately 30.15% while the percentage fall in demand for snowboards is -15%. Thus the cross elasticity of demand for snowboards is approximately -0.5 (i.e. -15% divided by 30.15%). They are complements. 3.1. Sketch the demand curve for both goods and explain the shape of the curves as you have drawn them. Price elasticity of demand for good A is very high while the price elasticity of demand for good B is almost negligible. Thus the shape of the curve for good A is much less steep while for good B it’s very steep. 3.2. What would you advice the firms producing these two goods to do if they wanted to increase their revenues? The producer of good A might decrease the by a greater percentage in order to increase his revenue collection while the producer of good B must increase the price. 3.3. Explain – in your own words – what the term ‘perfect elastic’ and ‘perfectly inelastic’ mean. Use diagrams to illustrate the demand curves for these types of product. Perfectly elastic means that even a very small price change, particularly an increase, would completely wipe out the demand for the good. On the other hand perfectly inelastic means that however bigger the price change (an increase) the change in demand would be negligibly smaller. 4. Revenues and costs are very important considerations for all businesses. Bavnara Company Ltd is a large global business with total revenues of £ 1.82 million. 4.1. If the business charges a price of £ 18.50 for its product, what level of output is currently being produced? 98,378 units 4.2. Explain what is meant by the term average revenue? What is the average revenue of Bavnara Company Ltd? Average revenue is obtained by dividing the total revenue by the number of units. The average revenue of Bavnara Company Ltd is approximately £18.50. 4.3. At what level of output should this business produce in order to maximize the level of profits it makes? (explain your answer using your own words) The company must produce beyond its breakeven level of output in order to maximize profits. In other words it must reach the margin of safety. 5. Profit maximizing is an objective that we assume firms pursue. Describe two other objectives that a firm might follow as an alternative to profit maximization and give examples of businesses that you think follow these alternative strategies. Revenue maximization and minimum average cost are the other two objectives that a firm can adopt. For example firms that have little overheads or extra costs would go for revenue maximization while firms that are expanding their scale of operations would seek to reduce the long term average cost. REFERENCES 01. Fox, KA, Johnson, S, Sengupta, J & Thorbecke, E 1992, Demand Analysis, Econometrics, and Policy Models: Selected Writings, Iowa State Press, Iowa. Read More