Question

A market research firm reports to Unilever Company ( which produces and sells butter) that the estimate of the cross price elasticity between magarine and butter is approximately 1.6. Unilever's price of butter is Ghs 60 per Kilo with sales of 1000 kilos per month. The price of margarine is GHs 25 per kilo with sales of 3500 kilos per month. The price elasticity of butter is estimated to be -3. What would be the effect on the revenue and sales of Unilever and margarine sellers if Unilever decided to cut price of butter to Ghs 54.

Answer 1

Price elasticity of butter = -3

Initial price of butter = Ghs 60 per kilo

Initial sales = 1,000 kilos

Initial revenue = Ghs 60 per kilo * 1,000 kilos = Ghs 60,000

New price = Ghs 54 per kilo

Calculate percentage decrease in price -

% decrease = [(54 - 60)/60] * 100 = -10%

Price elasticity of butter = % increase in quantity demanded of butter/% decrease in price of butter

-3 = % increase in quantity demanded of butter/-10

% increase in quantity demanded of butter = (-3) * (-10) = 30

New sales = old sales + increase in sales = 1,000 + (0.30 * 1,000) = 1,000 + 300 = 1,300 kilos

New revenue = 1,300 kilos * Ghs 54 per kilo = Ghs 70,200

Thus,

The sales and revenue of Unilever increases if Unilever decided to cut price of butter.

Initial price of magarine = Ghs 25 per kilo

Initial sales = 3,500 kilos

Initial revenue = Ghs 25 per kilo * 3,500 kilos = Ghs 87,500

Cross-price elasticity = % change in quantity demanded of magarine/% decrease in price of butter

1.6 = % change in quantity demanded of magarine/-10

% change in quantity demanded of magarine = -16

negative value indicates decrease.

Thus, sales of magarine will decrease by 16%.

new sales = old sales - decrease = 3,500 - (3,500 * 0.16) = 3,500 - 560 = 2,940 kilos

New revenue = Ghs 25 per kilo * 2,940 kilos = Ghs 73,500

Thus,

The sales and revenue of magarine sellers will decrease if Unilever decided to cut price of butter.