Question

3. Nestlé is a manufacturer of dairy products. His administration conducted an analysis of the chocolate division. As part of this analysis, it has been determined that personal income, sales prices and advertising expenses are the three main variables that affect the demand for chocolates. It has been estimated that the income arc elasticity for chocolates is 1.5 and that the arc price elasticity of demand is -2.0, as well as the arc elasticity of advertising is .8

a) Using these elasticities and the data below, calculate the missing sales:

Year Income Price Advertising Sales
2016 $ 1000 $ 400 $ 120 850
2017 $ 1100 $ 400 $ 130
2018 $ 1100 $ 450 $ 140

b) The company also has information that reveals that a competitor plans to reduce the price of its chocolates from $ 500 to $ 381 a box by 2017. The marketing department has estimated that the cross elasticity between the two companies is 0.3. How will the quantity react? Nestlé defendant? (calculate)

Answer 1

a)

Year	Income $	Change in I	Price $	Change in P	Advertising $	Change in A	Income Effect on Q	Price Effect on Q	Advertising effect on Q	Sales
Y	I	∆ I	P	∆ P	A	∆ A	∆I X 1.5	∆P X -2.0	∆A X 0.80	Q
2016	1000	-	400	-	120	-				850
2017	1100	100	400	-	130	10	150		8	1008	(850 + 150+8)
2018	1100	-	450	50	140	10		-500	8	516	(1008-500 +8)

b) Quantity for 2017 computed as follows:

Year	Income	Change in I	Advertising	Change in A	Competitor Price	Change in C	Income Effect	Advertising effect	Competition effect	Sales	Rounded off
Y	I	∆ I	A	∆ A	C	∆ C	∆I X 1.5	∆A X 0.80	∆ C X 0.3	Q
2016	1000	-	120	-	500					850
2017	1100	100	130	10	381	-119	150	8	-36	972	(850 + 150+8-36)

Therefore 2018 quantities as calculated in part a)also reduces by ~36 (due to fall in 2017 as in part b) because of cross elasticity.