Option 1 Note: The following is a regression equation. Standard errors are in pa

Question

Option 1

Note: The following is a regression equation. Standard errors are in parentheses for the demand for widgets.
QD       =          - 5200 - 42P + 20PX + 5.2I + 0.20A + 0.25M
(2.002) (17.5) (6.2)    (2.5)   (0.09)   (0.21)
R2 = 0.55           n = 26               F = 4.88

Your supervisor has asked you to compute the elasticities for each independent variable. Assume the following values for the independent variables:

Q          =          Quantity demanded of 3-pack units
P (in cents)       =          Price of the product = 500 cents per 3-pack unit
PX (in cents)     =          Price of leading competitor’s product = 600 cents per 3-pack unit
I (in dollars)       =          Per capita income of the standard metropolitan statistical area
(SMSA) in which the supermarkets are located = $5,500
A (in dollars)     =          Monthly advertising expenditures = $10,000
M                     =          Number of microwave ovens sold in the SMSA in which the
supermarkets are located = 5,000

Elasticities of independent variables are computed as follows.

Plugging in all values,

QD = - 5,200 - (42 x 500) + (20 x 600) + (5.2 x 5,500) + (0.2 x 10,000) + (0.25 x 5,000)

QD = - 5,200 - 21,000 + 12,000 + 28,600 + 2,000 + 1,250

QD = 17,650

Question 2. Determine the implications for each of the computed elasticities for the business in terms of short-term and long-term pricing strategies. Provide a rationale in which you cite your results.

Explanation / Answer

Only Question 2 is being answered as 1 seems to be done already. An own price elasticity of greater than 1 means that the demand for the product is price elastic and so a change in price causes a larger change in the quantity demanded. So to increase revenue the price of the product has to be reduced. The cross elasticity is positive thus the good is a substitute for X. The income elasticity is also greater than 1 and so the good has income elastic demand and so a change in income causes a larger change in demand. The advertising elasticity shows a very low demand responsiveness to a change in advertising. Thus the good in question appears to be a luxury good with substitutes available and so reducing price will increase its demand and so will an increase in income.

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