Question

3. Clark Marketing Services has found, through market tests, that the demand for Sonya’s Peanuts has a price elasticity of demand of 0.5 and an income elasticity of 1.8. You, an economist employed by Sonya’s peanuts, have been asked by your employers to explain what this means for its pricing policy and choice of sales outlets. Company executives have been thinking of lowering the firm’s prices and concentrating on selling to discount stores. What do you advise they do? Explain in a paragraph.

Answer 1

3. Clark Marketing Services has found, through market tests, that the demand for Sonya’s Peanuts has a price elasticity of demand of 0.5 and an income elasticity of 1.8. Now as the price elasticity of demand for peanuts is 0.5 which is less than 1, hence this suggests that the demand for Sonya's peanut is inelastic. Also as the income elasticity of demand for peanuts is 1.8 which is greater than 1 hence this means that peanut is a superior good. This means that for a specific group of consumers, people will buy peanuts even if the price increases. Now the demand for peanuts is inelastic I.e 0.5 which means that 1% increase in the price of peanuts will lead to a 0.5% decline in the quantity demanded for peanuts. Hence the total revenue earned from peanuts =( price*quantity) will increase as the increase in the price of peanuts will outweigh the decline in the sales of peanuts. Hence company executives claim of lowering the firm's price and selling to discount stores is false because if the lower the price of peanuts, sales of peanuts will not increase much and hence total revenue earned from peanuts will fall as decline in the price of peanuts will outweigh the increase in the sales of peanuts. Hence they should raise the price of peanuts in order to increase firm's revenue and profitability.