Question

Teena’s Business Venture Teena is an art teacher but a year ago, she decided to take a year’s leave without pay to start a new business. She became the owner of a coffee shop in AlBarsha. She is selling coffee and sandwiches. She has leased two coffee machines at a cost of AED 1600 per month. The monthly rent for the café is AED 5000. Her salary as a teacher was AED 8000 per month. Teena hired two university students to help her, paying each student a monthly salary of AED 3000. Her monthly expenditure on coffee beans and other ingredients is AED 4000 and AED1000 on other expenditures (electricity, cleaning, etc.). Teena faces the following demand curves for coffee and sandwiches. Demand curve for coffee per week Qd = 200 – 2 x P Demand curve for sandwiches per week Qd = 400 – 12 x P Teena has no knowledge of elementary microeconomics. She does not know how to calculate the elasticity of demand. She is currently charging a price of AED 20.00 per unit for both coffee and sandwiches and is thinking about increasing the price of both to AED 25.00 per unit.

A friend of Teena’s was an undergraduate business student who told her that for her business to be worthwhile she should be making at least normal profit. Teena was curious about the profit she made last month and consulted an accountant and an economist. She provided all the abovementioned information to the accountant and the economist. To her surprise, they come up with different values for the total profit before tax. This was very disturbing and confusing for Teena and she decided to consult an Economic student to organize her thinking.

You have to write Business Report

Explain the concept of price elasticity of demand to Teena and advise her about her pricing strategy for both coffee and sandwiches. Do you think it is a good idea for her to increase the price of both items from AED 20 to AED 25? Justify your answer. Given the information provided describe the type of market Teena’s coffee shop is operating in. Make sure you explain the features and the behaviour of firms in this type of market. Explain to Teena the meaning of “normal profit”. Does she need to exit the market if she is earning a normal profit.Calculate the elasticity of demand for both coffee and sandwiches when the price changes from AED20 to AED25.

Answer 1

FIRST OF ALL WE WILL CALCULATE THE EXPENSES OF HER COFFEE SHOP

(i) COFFEE MACHINE:- AED 3200

(ii) RENT :- AED 5000

(iii) SALARY OF 2 STUDENTS :- AED 6000

(iv) EXPENSES ON INGREDIENS :- AED 4000

(v) EXPENSES ON BUFFER THINGS :- AED 1000

TOTAL EXPENSES (PER MONTH) :- AED 19200

AS WE CALCULATED HER MONTHLY EXPENSES FOR RUNNING SHOP IS AED 19200 BUT HER INCOME IS

(i) INCOME BY SELLING COFFEE PER WEEK :- AED 3200

(ii) INCOME BY SELLING SANDWICHES PER WEEK :- AED 2800

INCOME PER WEEK :- AED 6000

INCOME PER MONTH :- AED 26000 (APPROAX)

SO PROFIT OF TEENA AFTER EXCLUDING EXPENSES :- AED 6800

PRICE ELASTICITY OF DEMAND IS A MEASURE OF RESPONSIVENESS OF CUSTOMERS TO CHANGE IN A PRODUCTS COST. IT CAN ALSO BE SAID IT IS PERCENTAGE CHANGE OF DEMAND TO PERCENTAGE CHANGE TO PRICE.

PRICING STATERGY SHOULD BE DONE IN SUCH A WAY THAT IT LEADS TO PROFIT TO TEENA BUT ALSO CONSIDERING THAT IT SHOULD NOT AFFECT CONSUMERS SO THAT HER SALES SHOULD NOT REDUCE DRASTICALLY.

INCREASING PRICE FROM BOTH ITEMS TO AED 25 FROM AED 20 IT WOULD BE A I THINK SO A BIG JUMP SHE SHOULD INCREASE PRICE OF ONE OF THE ITEMS RATHER THAN BOTH OF THEM OR INCREASE THE PRICE OF BOTH ITEMS BY AED 20 TO AED 22.

THE KIND OF MARKET IN WHCH TEENA SHOP IS WHERE THERE IS LESS ELASTIC DEMAND OR INELASTIC DEMAND (Ed<1) SO IF SHE INCREASES DEMAND SHE SHOULD ALSO CONSIDERED THAT HER DEMAND WILL ALSO AFFECTED.

WHEN THE PERCENTAGE CHANGE IN DEMAND IS LESS THAN PERCENTAGE CHANGE IN PRICE A GOOD IS A SAID TO HAVE LESS HAVE ELASTIC DEMAND. IN THIS KIND OF MARKET PEOPLE CHANGE THE PRODUCER OF SERVICE PROVIDER IF THE PRICE IS INCREASED AND THIS LEADS TO DECREASE OF DEMAND.

NORMAL PROFIT MEANS SHE SHOULD EARN ENOUGH SO THAT SHE COULD EARN THAT MUCH WHICH SHE WAS EARNING EARLIER AND SHE SHOULD NOT LEAVE THE MARKET EVEN SHE SHARTS EARNING NORMAL PROFIT SO SHE SHOULD WORK HARD TO EARN EXCEPTIONALLY GOOD PROFIT.

AS WE ARE NOT PROVIDED ANY INFORMATION RELATED TO Ed SO IT IS DIFFICULT TO CALULATE DEMAND. BUT I AM ASSUMING Ed=0.5 SO THE PERCENTAGE CHANGE IN DEMAND WILL BE 12.5%.