Question

In anticipation of the upcoming quarterly disclosure of profits, you prepare your Board of Directors for the challenge that cost-push inflation having on profits.

All America Grocery Inc - We serve communities in the middle of the income market providing low prices for all basic grocery needs. Our modest income consumers expect goods deals on good quality foods.  The Covid-19 pandemic has put upward pressure on the price of everything we sell. We have also experience in rising costs in every aspect of our operation as we have to put extra resources in protecting both our employees and the public. We are both fortunate and unfortunate that the price elasticity of demand for food is .20.  Explain

• Is the demand curve for your product relatively elastic, inelastic or unitary elastic?  Demonstrate for your company's product, by how much the quantity demanded will change if you pass on a 10% increase in cost. In other words, show your calculation of the percentage change in the quantity demanded given a 10% change in your price. You must provide calculations showing the percentage change in quantity demanded.
• Given your company's and the price elasticity of demand and the industry supply/competitive environment, you face preparing a statement for your board as to the potential impact on profits.   Who will pay the larger share of the cost increases, your firm, or your customers?

Answer 1

Cost push inflation is an inflation which is an outcome of rise in price of inputs like labour, raw material etc. The increase in price of these factor inputs has adverse effect on SUpply. The prices of commodity increases causing rise in overall general price level. The various other causes of cost push inflation other than increased cost of production include natural disaster, Monopoly, minimum wage legislation, etc.

This type of inflation generally occurs in case of inelastic demand as the demand cannot be easily adjusted according to rising prices. The demand for goods hasn't changed, the burden of Increased price are passed onto consumers creating cost-push inflation.

In case of All America grocery Inc:

Elasticity of demand is 0.20

The degree of elasticity of demand is less than 1. This is referred as inelastic demand. Inelastic demand refers to the percentage change in quantity demanded is less than percentage change in price. In this case demand for the commodity changes by less percentage even when the price increases by greater percentage. Essential good like vegetables generally have inelastic demand.

If the company' s cost of production rises by 10%, then the pressure of Increased cost will be seen in increases price . Price will also rise by 10%.

Price elasticity of demand = (-) percentage change in quantity demanded/ percentage change in price

0.20 = (-) percentage change in quantity demanded/ 10%

Percentage change in quantity demanded = 2%

Change in Quantity Demanded< change in price

Here the cost of production rises by 10%, the company can try to pass the additional costs on consumers by increasing the prices for their products. If they doesn't raise the price, while the Production cost Increases, the company's profit will decline.

When the demand for product is inelastic, company can raise price as demand doesnot change much. In case of inelastic demand, total revenue can rise by increasing price.

Increases cost of production can be shared with the customers as the demand is inelastic.