(30 points) Analysis of Pricing: You manage The Saco Atlantic Truffle Company wh

Question

(30 points) Analysis of Pricing: You manage The Saco Atlantic Truffle Company which makes a chocolate – caramel truffle for sale to gift shops from Cape Cod to Mount Desert Island near Bar Harbor Maine. In 2017, the company sold individually wrapped candies in boxes of 25 for $51.00 each. The candies retail for $4.49 for an individual piece and sales have been strong. The owners of Saco would like to increase its sales and profits. They know that, if price is lowered, they will generate more sales.   Sales are typically steady at 70,000 boxes per month from May through October. Last year they sold 70,000 boxes in May. So they run an experiment. Price is lowered to $46.00 per box in May of this year and the number of deliveries increases to 75,000.

What is the Price Elasticity of Demand?

Is elasticity elastic, inelastic or neither?

What does this mean and why does it matter?

Will Revenues increase or decrease as a result of the price cut? By How much?

You calculate that the fixed costs for the Saco Atlantic Truffle are $25,000 per month and each box costs $25 for the labor, candy, packaging and shipping. Will profits go up or down as a result of the price cut? By How much? (Profits are revenue minus all costs.)

Explanation / Answer

1) Price Elasticity of Demand (PED) = ((Q1-Q0) ÷ (Q1+Q0) ) ÷ ((P1-P0) ÷ (P1+P0))

= ((75000 - 70000) ÷ (75000+70000)) ÷ ((46-51) ÷ (46+51))

= -0.669

2) Since PED is less than 1, the demand is inelastic.

3) Demand is inelastic implies that change in quantity demanded responds only slightly to change in price. It matters because if significant change in price (sacrificing margins) translates into low increase in demand, it does not make sense from a business profitability perspective to lower the price.

4) For May, the initial revenue was 70,000*51 = 3570000

                 Revenue after price cut = 75,000*46 = 3450000

Therefore, decline in revenue = 3570000 - 3450000 = 120000

If price is maintained May to October, the decline in revenue for 6 months = 120000*6 = 720000

5) Profits at $51 per box = (70000*51) - (70000*25) - 25000 = 1795000

   Profits at $46 per box = (75000*46) - (75000*25) - 25000 = 1550000

Therefore, decline in profits = 1795000 - 1550000 = 245000

May to October decline = 245000*6 = 1470000

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