The following table lists the cross-price elasticities of demand for several goods, where the percent quantity change: Business Economic Case Study, SU, Malaysia

Question 1

The following table lists the cross-price elasticities of demand for several goods, where the percent quantity change is measured for the first good of the pair, and the percentage change in price is measured for the second good. 

• Explain the sign of each of the cross-price elasticities. What does it imply about the relationship between the two goods in question?
• Compare the absolute values of the cross-price elasticities and explain their magnitudes. For example, why is the cross-price elasticity of McDonald’s burgers and Burger King burgers less than the cross-price elasticity of butter and margarine?
• Use the information in the table to calculate how a 5% increase in the price of Pepsi affects the quantity of Coke demanded.

QUESTION 2:  

A monopolistic competitive firm’s strategy is to increase market share.

• What are the TWO (2) important sources of market power for monopolistic competitive firms to determine the price in the market? Explain
• Explain how farms can increase profit under monopolistic competition.

Question 3:

Read the case study entitled ‘The role of advertising and answer the following THREE (3) questions:

Case Study: The role of advertising

Firms often spend thousands to millions of dollars per year on advertising and other forms of marketing. In terms of demand analysis, the aim is twofold. Advertising is designed to inform the consumer of the product and influence their tastes and preferences. A successful advertising campaign should result in an increase in the demand for the product at each given price level, thereby shifting the demand curve to the right.

Advertising is also designed to increase brand loyalty. Successful advertising and marketing will enable consumers to associate a certain lifestyle or image with the product. If firms are able to successfully create a sense of brand loyalty, then this makes their competitors’ products less viable as alternatives. Therefore, a successful advertising campaign can decrease the Price Elasticity of Demand (PED) for their product.

A lower PED for a product may allow the company to charge higher prices and gain an increase in revenue. This may help to explain why some designers or luxury brands are able to charge far more than what it costs to produce their products.

Questions

1. Explain what is meant by brand loyalty and outline how advertising can generate brand loyalty.
2. Discuss the possible relationship between an increase in advertising expenditure, brand loyalty, and the Price Elasticity of Demand.
3. Explain why it is considered to be profit-maximizing behavior if a business raises the price on those products with a low Price Elasticity of Demand.

Question 4:

The University Book Store is the only store (hence, it is a monopoly) that sells Krugman’s books to the Economics class. The staff of book store can only identify customers as morning class or afternoon class, but other than that they all look the same.

This monopolist faces demand from two groups of consumers and they charge relatively higher prices to the afternoon class customers. This problem assumes that the bookstore is able to price discriminate between the two markets.

• Draw a diagram of monopolist price discrimination.
• Which group of customers has the more elastic demand curve?
• Which class gives the monopolist the greater revenue?
• Which class pays the higher price?

Answer

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