Big Mouth Megaphones has a booming business in perfectly competitive market. The new General Manager Sam Adams, a staunch follower of the NomoTax Party learned in a graduate Econ class at Ohio Lesserthan Univerity that he should pass on the cost of income taxes to his customers. Based on the last year's results, Sam used the simple profit equation to forecast the (Net Income After Tax (NIAT). (Sales-Expense = Profit and NIAT = Profit X (1-FITR). Assume the FITR = 35%. Sam has estimated his expenses at 85% of Sales. He added the FIT bill to the price.
a. What happens to the Price, and to the NIAT?
b. Why or why not will this put more money in Big Mouth's pocket?
Before Sam could boast on his brilliance he began to feel the stress on volume and tighter cash flow. He remembered a Bible verse that said there is safety in a multitude of counselors. So he called a professor at another university who once said, "call me if I can every help with anything." Prof. Nike Swoosh at IWU referred him to you and your arsenal of economic tools to apply to the problem.
Please help Sam get his pricing right.
Last year Big Mouth sold 90 megaphones per month at $100 each. After increasing the prices to pass on the tax bill volume decreased to 65 units per month. (do all analysis on the per month basis)
c. What is the arc elasticity ( Ep ) of the megaphone demand?
d. What is the Marginal Revenue?
e. At what price is profit maximized [ use: Popt = ((Ep /(1-Ep)) x MC ]?
f. What should be Sam's key learnings?