ECO 547 Fall 2000

First Exam

NAME______

10 points each

1. The following is ABU GARCIA sells fishing equipment. Their monthly demand relationship for fishing rods is:

Qrods = 150 - 10Prods +10A- 2Preels + 5Prods2 +20N

The variables available are:

Variable / Definition / 2000 / Projected 2001
Prods / Price of Abu Garcia rods / 20 / 15
A / Annual advertising budget in thousands / 5 / 10
Preels / Price of Abu Garcia fishing reels / 20 / 25
Prods2 / Price of competitor’s rods / 20 / 20
N / Population in thousands / 10 / 10

Abu Garcia executives were not satisfied with their sales revenue for this year (2000). They have devised a bold strategy for next year. Their plan is to cut their price dramatically in conjunction with an advertising blitz.

1.  Evaluate and interpret the demand relationship. i.e. What does it mean, and are there missing variables?

For each one dollar increase in price monthly demand for rods will fall by 10 units

For each thousand dollar annual increase in advertising, AG will sell 10 more rods per month.

For each one dollar increase in the price of reels, monthly demand for AG rods will fall by 2.

For each one dollar increase in the price of the competitor’s rods, AG will sell 5 more rods per month.

For each 1000 person increase in the population, demand for rods will rise by 20 per month.

Missing: Income, Tastes (season would be important for any outdoor activity)

2. Calculate and interpret all of the elasticities for this year 2000.

Qrods = 150 - 10Prods +10A- 2Preels + 5Prods2 +20N
variable / coef / Variable200 / C*V / Elasticity
constant / 150 / 1 / 150
Pr / -10 / 20 / -200 / -0.76923 / if price rises one percent demand falls .76 percent: inelastic
A / 10 / 5 / 50 / 0.192308 / If advertising rises one percent demand falls .19 percent
Pre / -2 / 20 / -40 / -0.15385 / If price of reels rises one percent demand falls .15 percent complements
Pr2 / 5 / 20 / 100 / 0.384615 / If price of other rods rises by one percent our demand rises by .38 percent: substitutes
N / 20 / 10 / 200 / 0.769231 / If population rises by one percent, our demand rises by .77 percent
Q= / 260

3. Calculate the demand curve, the inverse demand curve and the total revenue function for next year (2001). Sketch demand and total revenue. Indicate the firm's current position (roughly) on each curve.

Qrods = 150 - 10Prods +10*10- 2*25 + 5*20 +20*10

Q = 500 – 10P

P = 50 - .1Q

TR= 50Q- .1Q2

P

50

Based on the elasticity they are on the bottom half of D.

D

500 Q

TR

500

Q

4.  At what quantity is total revenue maximized? Evaluate their pricing decision and relate this to your price elasticity calculation from question 2.

TR= 50Q- .1Q2

TR’ = 50 - .2Q =0

Q= 250

P = 25

Their idea to drop the price will reduce revenue. They should increase the price to something over $25, if their intent is to maximize profits.

5.  Does the advertising blitz sound like a good idea?

For each thousand dollar annual increase in advertising, AG will sell 10 more rods per month. So that’s 120 rods per year. Assuming a $25 price, that’s 3,000 in revenue. So if 3,000 in revenue equates to over 1,000 in profit, then the advertising will be a good idea.