# Assignment 1 Demand Estimation

DEMAND ESTIMATION 9

Assignment1: Demand Estimation

Option1

QD= – 5200 – 42P + 20PX + 5.2I + 0.20A + 0.25M

Inorder to obtain QD value, substitute the real values of the variables

QD= -5200 – 42(5) + 20(6) + 5.2(5500) + 0.2(10,000) + 0.25(5000)

=-5200 – 210 + 120 + 28,600 + 2000 + 1250

=26560

PriceElasticity = -42 * 5/26560

=-0.008

CrossElasticity = 20 * 6/26560

=0.005

IncomeElasticity = 5.2 * 5500/26560

=1.08

=0.08

OvenElasticity = 0.25 * 5,000/26560

=0.05

Option2

QuantityDemanded = QD = -2,000 – 100P + 15A + 25PX + 10I

Inorder to obtain the value of QD, substitute the real values of thevariables. In this case, QD will be as follows

QD= -2,000 – 100 (2) + 15 (640) + 25 (3) + 10 (5,000)

=-2000 – 200 + 9600 + 75 + 50,000

QD=57475

PriceElasticity = -100 * 2/57475

=-0.03

=0.17

CrossElasticity = 25 * 3/57475

=0.001

IncomeElasticity = 10 * 5,000/57475

=0.87

Implications

Fromthe calculations of price elasticity in option 1 and option 2, itemerged that the elasticity was less than one in the case of option1, the elasticity was -0.008 while in option 2 the elasticity was–0.03. This is an indication that in case price is increased inboth option 1 and option 2, the revenues collected will be low. Thisemanates from the reasoning that consumers are responsive to pricechanges. Thus, in both option 1 and option 2, revenues can only beincreased through lowering the price of the commodity. This isbecause as the price goes down the spending on the commodity willalso go down, making consumers spend more on the commodity since theydeem the prices to be affordable. However, this would only takeeffect in the long run. In the short run, a change in price may notbe easily felt. So, in the short run, consumers may change theirpurchasing behavior despite a price change.

Inthe case of cross elasticity, both option 1 and option 2 havepositive cross elasticity. This is an indication that the commoditiesbeing considered in both option 1 and option 2 are substitutes.However, the elasticity in both cases are less than one 0.005 foroption 1and 0.001 for option 2. This indicates that although thecommodities being considered in the options are substitutes, they arenot good substitutes and the price of the competitor would havelittle impact for the sales of the business. Because the commoditiesare not perfect substitutes, a change in price both in the short andlong run will not have a lot of impact.

Inthe case of Income elasticity, option 1 indicates a positive incomeelasticity that is more than one. This implies that the commodity isincome elastic and is a superior or luxury good. Being a superiorgood, the commodity is responsive to changes in income both in theshort and long run. On the other hand, in option 2, the income ispositive but less than 1. This implies that, in option 2, thecommodity is a necessity good (McEachern, 2012). Given that thecommodity is a necessity, a change in price will not change quantitydemanded in the short run however, in the long run, an increase inprice would trigger consumers to look for alternatives.

Foradvertising elasticity, the elasticity is less than one. This is anindication that the commodities in both option 1 and 2 are inelasticwith respect to advertising. In both cases, a 1% increase in theadvertising expenses will result in a less than 1% increase in sales.This implies that advertising is not a significant factor since ithas little effect on sales.

Iwould recommend that the business should not cut down its prices. Incase the business cuts its prices, then the revenues of the businesswill also fall. This is because from both options, the priceelasticity is less than one. This implies that it would be difficultfor the business to increase its sales in case it drops its prices.Also, the cross elasticity in both options is very close to zero.Therefore, it would not be advisable for the business to lower itsprices further in an attempt to increase its market share.

Option1Demand Curve

Option2 Demand Curve

SupplyCurve

EquilibriumPrice and Quantity

Consideringoption 1,

Qd= 26770 – 42P

Qs= -7909.89 + 79.1P

AtEquilibrium, Qd = Qs

26770– 42P = -7909.89 + 79.1P

121.1P= 34679.89

P= 286.37

Substitutingthe value of P Q = -7909.89 + 79.1(286.37)

Q= 14741.98

Option2

57675– 100P = -7909.89 + 79.1P

179.1P= 65584.89

P= 366.19

Q= -7909.89 + 79.1(366.19)

Q= 21055.74

Factorsfor Change

Thereare different factors that can make the demand and supply of thecommodity change. The demand for the low calorie food may change as aresult of factors such as changes in consumer income, the price of arival product, and changes in tastes and preferences of consumers(McEachern, 2012). A short-term decrease in consumer income may nothave an adverse effect on the commodity, but long-term decrease inconsumer income may adversely affect the demand of the commodity. Onthe other hand, the supply for the low calorie food may change as aresult of factors such as change in the number of suppliers of thecommodity, changes in technology, change in the raw materials andlabor (McEachern, 2012). Short-term factors like change in suppliernumbers and changes in labor and raw materials cannot adverselyaffect the supply of the commodity however, long-term factors suchas change in technology can adversely affect the supply of thecommodity because technology may be expensive to adopt.

CrucialFactors

Aleftward shift of the demand curve for the commodity can be caused bya decrease in the consumers’ income. Besides, in case the economyexperience recession, the demand curve for the commodity may also beshifted to the left. A rightward shift in the demand curve for thecommodity may be as a result of an augment in consumer income.Besides, in case the price of substitutes decreases, the demand curveof the commodity will shift to the right. On the other hand, supplycurve for the commodity can be made to shift to the right byadvancement in technology. Alternatively, the supply curve wouldshift to the left in case the price of labor increases orunavailability of labor.

References

McEachern,W. A. (2012). Microeconomics:A contemporary introduction.Mason, OH: South-Western Cengage Learning.