The Dolly Madison Inc at Emporia estimated the following elasticities for a spec
ID: 1216690 • Letter: T
Question
The Dolly Madison Inc at Emporia estimated the following elasticities for a special type of doughnuts: price elasticity EP = 2, income elasticity EI = 1, and cross elasticity EXY = 1.5, where X refers to doughnuts and Y to bagels. Next year, the firm would like to increase the price of the doughnuts it sells by 6 percent. Management forecasts that income will rise by 4 percent next year and that the price of bagels will fall by 2 percent. (a) If the sales this year are 120,000 doughnuts, how many doughnuts can the firm expect to sell next year? (b) By what percentage must the firm change the price of doughnuts to keep its sales at 120,000 tons next year?Explanation / Answer
Next year, the firm would like to increase the price of the doughnuts it sells by 6 percent. Management forecasts that income will rise by 4 percent next year and that the price of bagels will fall by 2 %
so due to price rise of 6%, as Ep = 2, demand will decrease by 12%
due to rise in income by 4% as EI= 1, demand will increase by 4%
de to fall in price of bagels by 2%, as EXY = 1.5, demand will decrease by 3%
net change in demand = - 11% or decrease by 11%
sales next year will be 89% of thi year sale = 89*120000/100= 106800
b) By what percentage must the firm change the price of doughnuts to keep its sales at 120,000 tons next year
total change in demand due to income and price of bagels= 1% or increase of 1%
in order to keep sales at same level, price needs to be increased by 0.5 %
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