Question

You are Marketing Manager for Bud Beer, produced by the Budweiser Division of

Anheuser-Busch, the brewing company with the highest market share in the United States. The

second-highest market share belongs to Miller’s Beer, produced by Miller Brewer Company. So you know that Miller’s is your most-important competitor. You also know that watching football on TV makes beer more enjoyable. Therefore Bud sales (the demand for Bud Beer—quantity of Bud Beer demanded, number of six-packs per week) depends on the price of Bud beer (dollars per six-pack), the price of Miller’s Beer (dollars per six-pack), and TV football (number of football games on TV per week). Currently, the level of Bud sales is eight million six-packs weekly.

Here are three scenarios, which are independent of each other; so they should be answered separately. Parts (a) and (b) of scenarios 1 and 2 are each worth one point, and scenario 3 is worth one point. Thus a total maximum point score of five.

Scenario 1. The CEO asks you to predict the increase in Bud sales if Bud price is reduced by ten percent. You have to make a sensible prediction.

(a) In the context of this scenario, what elasticity information do you need? (i) Name this elasticity (ii) Define this elasticity.

(b) What assumptions must you make using this elasticity for your prediction? Explain your answer.

Scenario 2. The CEO has learned that Miller will reduce the price of its beer by five percent. The CEO wants to know the effect on Bud sales if she does not reduce the price of Bud beer and if TV football is unchanged. Your staff informs you that the cross-price elasticity of the demand for Bud beer with respect to the price of Miller’s beer is 2.

(a) Why is this elasticity positive (+2) rather than negative (-2)? Explain thoroughly.

(b) What is the new level of Bud sales (number of six-packs per week)? Show your computation.

Hint: Be sure to distinguish between the change in sales and the new level of sales.

Scenario 3. The National Football League announces that TV football will increase from 95 games to 105 games. Your staff informs you that, assuming the price of Bud beer and the price of Miller’s beer do not change, Bud sales will increase from eight million to ten million weekly.

Using the “midpoint method,” compute the “elasticity of demand for Bud beer with respect to TV football.” Show your computation.

Answer 1

Scenario 1:

a) The elasticity information needed is how the quantity demanded of Bud sales would change when the price of Bud beer reduces by 10%. So the percentage change of both price change and quantity demanded due to it.

i) This is the price elasticity of demand.

ii) price elasticity of demand shows how the demand changes when nothing but the price changes ie the responsiveness of demand with respect to price.

b) The basic assumption of this elasticity is that law of demand exists. Law of demand states that there exists inverse relation between price and quantity demanded of the good.When the price reduces, the demand would increase. Here also the sign of elasticity of demand would be negative due to the same reason.

Scenario 2:

a) Miller beer and bud beer are substitutes ie one could be consumed in place is another.

It is given that Miller beer would be reducing its prices. This implies that now it would be cheaper than Bud beer. So the demand for bud beer would reduce and of Miller beer woulw increase. Hence the decrease in price of Miller beer would reduce the demand for bud beer(so they are moving in the same direction). Hence the sign of elasticity would be positive.

b) formula for cross price elasticity of demand is given by

Ed=% change in quantity (sales) of bud beer / % change in price of Miller beer

+2 = % change in sales of bud beer/ 5%

10% = % change in sales of bud beer

So the decrease in sales of bud beer due to decrease in price of Miller beer is 10%.

Earlier 8 million six pack of bud beers were sold in a week. Now reducing it by 10% we get 8million -0.8million = 7.2million.

So now the sales is 7.2 million of bud beers(six pack per week)

Scenario 3:

Midpoint method:

Ed= [Q2-Q1/{(Q1+Q2)/2}]/[P2-P1/{(P1+P2)/2}]

Where P is the Tv football games and Q is the quantity if bud beer.

Ed= [2/ (18/2)]/[10/(95+105)/2]

Ed= 2/9÷10/100= 2/9*100/10

Ed= 20/9 =(+)2.22

(You can comment for doubts)