Exercise 2 – Demand Analysis

Instructions: Write down your answers in Word document. For short answer questions, you have a
maximum of 200 words only, written in English or Filipino. For problem solving, show full computations
in the same document. If asked to illustrate diagrams, you may illustrate using charts and smart arts or
paste a photo of your hand-drawn illustration in the same document. You may discuss the questions and
solutions with your classmates, but please do not copy-paste answers. Answer the requirements with
integrity and honesty. Encircle or highlight the final answer. (Total: 15 points)

Short Answer Questions

1. During a five-year period, the ticket sales of a city’s professional basketball team have
increased 30 percent at the same time that average ticket prices have risen by 50 percent. Do
these changes imply an upward-sloping demand curve? Explain. (2 points)

- As for the description in the law of demand, it states that the quantity demanded of a
product increase (decreases) when the price decreases (increases). In this case, the ticket
sales increased by 30% thus the ticket price also increased by 50% from its average price.
These changes imply a down-sloping demand curve because increased sales do not reject
the law of downward-sloping demand. Other factors, such as increased population and/or
income, or increased promotion, could have contributed to the increased ticket sales,
despite the higher prices.

2. As economic consultant to the dominant firm in a particular market, you have discovered that,
at the current price and output, demand for your client’s product is price inelastic. What
advice regarding pricing would you give? (2 points)

- Price inelastic means that even if the price increases, consumers' purchasing habits will stay
constant. They will still buy whatever you have to offer. When prices decrease, consumers'
purchasing habits remain unchanged. As an economic consultant, I would advise the client
to raise the product's pricing. Consumers will still buy the product despite its higher price
because it is inelastic. As a result, increasing the price will result in the same number of
customers paying more for the product. The company's revenue will rise as a result of this
advice.

3. In what respects are the following common practices subtle (or not-so subtle) forms of price
discrimination? (3 points)

a. Frequent-flier and frequent-stay programs

- The airline industry uses frequent-flier programs to provide incentives and rewards to
customers who have been loyal travelers. This strategy is used to lower travel costs in order
to persuade customers to become loyal to the airline and become lifetime customers,
whereas frequent-stay is a program that provides free hotel stays to frequent travelers. This
program was created by the hotel industry to ensure that as business people and travelers
spend more time in hotels, they earn points that will eventually allow them to take
advantage of incentives such as free nights. Frequent-flier and frequent-stay programs are

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Exercise 2 – Demand Analysis

strategies for increasing traveler loyalty. This type of reward program is quite unknown
therefore it means that this is not a subtle form of price discrimination. Because this type of
reward program is so unusual, it cannot be considered a subtle form of price discrimination.
b. Manufacturers’ discount coupon programs

- Manufacturers' discount coupon programs are developed to reduce the cost of goods and
services by offering discounts to those who can meet the manufacturer's set prices. This
program varies from price reductions that are made directly. Discount coupons are used by
manufacturers to target a specific set of customers with price elasticity. Some clients have
more flexible demands than others so the discount coupons are thus a subtle means of
discriminating against the prices of goods and services.

c. A retailer’s guarantee to match a lower competing price

- This is a situation in which retailers make an implicit promise to customers to sell products
at a specific price in order to outdo competitors' prices. When profit margins are reduced, it
usually does not work well for retailers. As a result, it is unlikely to be a subtle form of price
discrimination.

Problem Solving

1. (4 points) Management of McPablo’s Food Shops has completed a study of weekly demand for
its “old-fashioned” tacos in 53 regional markets. The study revealed that

Q = 400 – 1,200P + 0.8A + 55Pop + 800P o

where Q is the number of tacos sold per store per week, A is the level of local advertising
expenditure (in dollars), Pop denotes the local population (in thousands), and P o is the average
taco price of local competitors. For the typical McPablo’s outlet, P = $1.50, A = $1,000, Pop =
40, and Po = $1.
a. Estimate the weekly sales for the typical McPablo’s outlet.

Q = 400 – (1,200) (1.5) + (.8) (1,000) + (55) (40) + (800) (1)

b. What is the current price elasticity for tacos?

E(p) = -1,200 (p)

E(p) = -1,200 (1.50)

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Exercise 2 – Demand Analysis

c. What is the advertising elasticity?

E(a) = (0.8) (1,000)

d. Should McPablo’s raise its taco prices? Why or why not?

- Since demand is inelastic, it will not change the buying behavior of the consumer, so
McPablo should rise its taco prices to increase revenue.

2. (4 points) During the 1990s, Apple Computer saw its global share of the personal computer
market fall from above 10 percent to less than 5 percent. Despite a keenly loyal customer
base, Apple found it more and more difficult to compete in a market dominated by the
majority standard: PCs with Microsoft’s Windows based operating system and Intel’s
microchips. Indeed, software developers put a lower priority on writing Mac applications than
on Windows applications.

a. In the late 1980s and 1990s, Apple vigorously protected its proprietary hardware and
software and refused to license Mac clones. What effect did this decision have on long-
run demand?

- Apple's refusal to grant permission to Mac clones will result in a drop in demand. This drop
in demand will most likely occur as a result of factors such as competition in the computer
market.

b. In the early 1990s, Apple enjoyed high markups on its units. In 1995 Apple’s chief, John
Sculley, insisted on keeping Mac’s gross profit margin at 50 to 55 percent, even in the
face of falling demand. (Gross profit margin is measured as total revenue minus total
variable costs expressed as a percentage of total revenue.) At this time, the business
of selling PCs was becoming more and more “commodity-like.” Indeed, the price
elasticity facing a particular company was estimated in the neighborhood of EP = -4.
Using the markup rule of Equation 3.12, carefully assess Sculley’s strategy.

P = MC/ (1+1/Ep)
= MC/ 0.75
= (4/3 MC-MC) (4/3MC)

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Exercise 2 – Demand Analysis

= (1/3) / (4/3)
= 0.25 X 100
= 25%
As a result, John Scully's profit margin of 50 - 55 percent is excessive. In the case
of Apple, the profit margin should be 25%. John Scully acted like a monopolist with a
unique product, and his strategy failed.

c. In the last decade, Apple has discontinued several of its lower-priced models and has
expanded its efforts in the education and desktop publishing markets. In addition,
recent software innovations allow Macs to read most documents, data, and
spreadsheets generated on other PCs. Do these initiatives make sense? How will they
affect demand?

- Yes, this Mac innovation will most likely be beneficial to students or workers. Macs will be
more accessible and convenient when working with documents created in other computer
formats. Because of this innovation, its demand is likely to increase due to its useful function
and features.