Tutorial 3 Industry Application Questions PDF

Preview

Summary

Tutorial 3 – Industry Application QuestionsQuestion 1Discuss each of the factors that determine the price elasticity of a product with respect to the product or product category listed for your industry. Do you think this product or product category is likely to have a price elasticity of demand tha...

Description

Tutorial 3 – Industry Application Questions Question 1 Discuss each of the factors that determine the price elasticity of a product with respect to the product or product category listed for your industry. Do you think this product or product category is likely to have a price elasticity of demand that is elastic or inelastic at their current market price levels, looking over a period of 6 months? 5 + 2 marks Substitutability for coffee can occur, however; many of coffee consumers of a standard cappuccino would not substitute another drink for this alternative. Looking at substitutes such as other caffeinated drinks, including tea, instant coffee, iced drinks and energy drinks, this can be substituted for the caffeine hit. In terms of the coffee type, a cappuccino is a very specific type of coffee, with other types including latte, flat white, mocha, long black etc. These can be classed as a substitute for a cappuccino if this left the market; however, the espresso coffee itself is a very characteristic product which many people do not want to substitute, even if the price increases. This then refers to the preference of the consumer, many will preference coffee over other drinks, including caffeinated and hot drinks. With a standard cappuccino being a relatively inexpensive item, a limited increase in price could see little change to demand as many people rely on a coffee for their work mornings. The share of the budget and income would also have little effect on the demand. A standard coffee being relatively low cost at $4 throughout Australia, this of a daily/weekly budget seems very minimal; however, if this $4 coffee is bought 5 times a week, 52 weeks of the year, this total to be $1000 (around 1.5% of the average full-time worker’s salary). Many people still do not see this cost as an expense that needs to be reduced or cut, and continue to buy without hassle. This proportion of 1% does not seem to be extremely high, which means that it makes the product inelastic as consumers would continue to buy until the proportion of their income increases. Time is a factor of price elasticity of a demanded product, which means that the period following a price change can affect the consumption of the product. For instance, if the price of a cappuccino was to increase, the demand would shortly decrease, making the product relatively elastic for this period; however, if the consumer searched for a substitute and was unsuccessful, the demand for cappuccinos would again increase which would return to an inelastic demand, as the price has changed but the demand is still fairly the same. In retrospect to this, the substitutability also plays an important role in this time factor, if another similar espresso coffee product was not impacted by the price increase, the demand for cappuccinos would decrease and the demand would be reduced for an increased period. Luxuries versus necessities also is a factor on the price elasticity of a demand, which can be impacted by a range of issues. A cappuccino can be viewed very differently by many consumers, this also being factored by income, reliance, routine etc. An espresso coffee, especially a cappuccino is drunk by hundreds of thousands every day. This can be either seen to many as a luxury or necessity, which again defines whether the product is elastic or inelastic. For consumers that have a stable, above average income, the cappuccino becomes part of a daily routine and is a necessity to start the day. With nearly 46% of the Australian population drinking coffee, this statistic demonstrates a heightened demand for the product. For this category of drinkers, the necessity indicates an inelastic demand for a cappuccino, as the price, supply and substitutability

of the product does not impact the consumers need for it. In comparison, those who have a lower average income, can find an inexpensive substitute and do not rely on coffee in their morning routine can see this as more of a luxury item, making it elastic in demand. Brand and Category does not play a large role in the demand for coffee, or the elasticity of the product. Cappuccinos and coffee in general, are generally not deemed worthy or not by a brand; however, some connoisseurs have a taste for different brands, yet this doesn’t make up most the consumer market. Category, of product will be elastic generally. Yet coffee, is in such a wide array of category – being hot beverages, can have an impact on this elasticity. This means that there are many substitutes for the hot beverage, which shows the consumer can easily replace the cappuccino they buy. Yet, the other factors still take part with preference, time and share of budget playing an important role in this elasticity. Question 2 The CEO of the Industry Association that works to advise firms in your industry wants to increase total revenue in your industry, and is considering advising all the firms in the industry to increase their recommended retail price for the appropriate product or product category as above in question 1. Write a short paragraph that explains to CEO of the Industry Association whether this is a suitable course of action for them to recommend, and why. 4 marks The coffee and café industry is always subject to price variation; however, these are still minimal. To increase revenue in this sector, your increase would need to be a barely noticeable change, to both beverages and food. The following factors have demonstrated that coffee (espresso, cappuccinos), is inelastic. As substitutability for espresso coffee and cappuccinos is relatively moderate, the need for consumers to go elsewhere could happen with any increase in price; moreover, the need for the product can be influenced by the cost and how this will affect the weekly budget of households and consumers. A large increase in cost, making a larger proportion of a budget would decrease the demand and make the product more elastic. Yet, as a small increase of maybe 50cents to 1 dollar, would still make the product a relatively inexpensive item to a budget, although this still may be received poorly. Consumers tend to spend a large amount of time searching for substitutes if they feel that the product that is usually bought, is no longer worthy of the money it costs, this being a problem if a large increase in price occurred. Comparatively, coffee is a product that many people see as a necessity, which may be hard to steer away from to another product. This links to the factor of whether espresso cappuccinos are a luxury or necessity, this depends on the characteristics of the consumer, many cannot afford the ‘luxury’ of espresso, barista made coffee, whereas others do not see the gap in their income from this ‘necessity’. An increase in price would widen the gap of these two categories of consumers, making coffee a normal product for those with a large income, yet even more of a luxury, unaffordable alternative to instant coffee for those with a smaller income. Raising the price of coffee would need to be a positive for the industry, demonstrating to consumers that the increase will not reduce the quality, need or supply of the product. As a mostly inelastic product, an espresso coffee will not be impacted largely by an increase in price, the demand may fall for a limited time, yet will return to a normal type demand for the industry.

Question 3 Irrespective of your answers to questions 1 and 2 above, assume your product or product category has a price elasticity of demand of 1.2 How would demand for the product change if the price of the product decreased by 10%? Would total revenue for the product or product category increase or decrease? 3 marks As the price elasticity of demand for this product is 1.2, this is elastic, yet not overly so. A price decrease of 10% would have an adverse effect on the demand of the product. As the demand is very responsive to price, the suppliers and industry would see a dramatic increase in demand. This would then lead to a shortage of supply, as a decrease in price sees a shift to the left of the supply curve. As this shortage occurs, the suppliers would see a shortage, however; as the demand has increased, the more units bought will lead to an increase in revenue. This decrease in price would be a temporary revenue builder for the industry, however; the price would have to return to its equilibrium point to ensure enough supply and demand for the product....