1. Sales of cars declined by 15 per cent in a recent recession. During this period the price of cars rose by 6 per cent, average income fell by 4 per cent and the price of petrol rose by 20 per cent. It has been estimated that the PED for cars is - 0.8 and the YED is 1.25.
a. Estimate the effect of the decline in income on car sales.
b. Estimate the effect of the car price rise on sales.
c. Estimate the CED between petrol and cars; compare your estimate using simple elasticities and additive effects with the estimate obtained using a power form of demand equation.
2. MK Corp estimates that its demand function is as follows:
Q ¼ 400 12:5P þ 25A þ 14Y þ 10P_________________________________where Q is the quantity demanded per month, P is the product's price (in $), A is the firm's advertising expenditure (in 000 per month), Y is per capita disposable income (in 000), and P * is the price of AJ Corp.
a. During the next five years, per capita disposable income is expected to increase by $5,000 and AJ is expected to increase its price by $12. What effect will this have on the firm's sales volume?
b. If MK wants to change its price by enough to offset the above effects, by how much must it do so?
c. Compare the profitability of maintaining sales volume by either changing price or changing advertising spending.
d. If MK's current price is $60 and it spends $10,000 per month on advertising, while per capita income is $25,000 and AJ's price is $70, calculate the price elasticity of demand with the price change.
e. What can be said about the effect of the above price change on profit?
f. What can be said about the relationship between the products of MK and AJ?