Question

ZPharma Co., a pharmaceutical company, sells three different products: Zdiet, a Weight Loss Medication, Zataflam, a Non-Steroidal Anti-Inflammatory and Zolymox, an Antibiotic. Due to a new government regulation with regard to pricing medications, suppose that the prices of these products have increased as follows: Zdiet (25%), Zataflam, (20%) and Zolymox, (10%). As a result, the monthly quantity sold from each product declined by the following percentages: Zdiet (35%), Zataflam (12%), and Zolymox (5%). Calculate the price elasticity of demand for the three products: Zdiet, Zataflam and Zolymox. Interpret your results to the best of your ability. Analyze the potential effect of the increase in prices on sales revenue of each product. Now, suppose the decline in demand indicated above was caused by a 20% decrease in income level. How would you best describe each product

Answer 1

Solution

Price elasticity of demand = % Change in quantity demanded / % Change in Price

Calculating the price elasticities of all the 3 products

Price elasticity of demand of Zdiet = ( -35% / 10%) i.e.- 3.5

Price elasticity of demand of Zataflam = (-12% / 10%) i.e., -1.2

Price elasticity of demand of Zolymox = (-5% / 10%) i.e., - 0.5

So the price elasticity of demand for Zdiet and Zataflam are highly elastic in nature as they are more than 1. It indicates for 1 unit change in their price,their sales revenue changes more than 1%.Price and quantity as you know will be opposite direction.So,for every 1 % increase in their prices,the sales revenues of Zdiet and Zataflam will reduce by 3.5% and 1.2% respectively.So,the revenue for the company for these products decreases.

On the other hand,in the case Zolymox ,for every 1 % increase in price,the quantity demanded reduces by only 0.5%. In other words,it is inelastic.So,here the revenue of the company from this product increases.

Income elasticity of demand

Income elasticity of demand = % Change in quantity demanded / % Change in Income

Calculating the income elasticities of all the 3 products

Income elasticity of demand of Zdiet = ( -35% / - 20%) i.e. 1.75

Income elasticity of demand of Zataflam = (-12% / - 20%) i.e., 0.60

Income elasticity of demand of Zolymox = (-5% / -20%) i.e., 0.25

Only Zataflam is highly elastic.

In case of Zataflam and Zolymox,they are inelastic meaning their demand has reduced lesser when compared to the decrease in their income levels (i.e., purchasing power).

Company's revenue from all the 3 products will decrease because the sales revenue is decreasing.

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