Answered Essay: You manage The Springvale Seaside Caramel Company which makes a chocolate

You manage The Springvale Seaside Caramel Company which makes a chocolate – caramel truffle for sale to gift shops from Cape Cod to Mount Desert Island near Bar Harbor Maine. The company sells individually wrapped candies in boxes of 50 for $81.00 each. The candies retail for $3.99 for an individual piece and sales have been strong. The owners of the Seaside would like to increase its sales and profits. They know that, if price is lowered, they will generate more sales.   Sales are typically steady at 35,000 boxes per month from May through October. Last year they sold 35,000 boxes in May. So they run an experiment. Price is lowered to $73.00 per box in May of this year and the number of deliveries increases to 37,000.

What is the Price Elasticity of Demand?

Is elasticity elastic, inelastic or neither?

What does this mean and why does it matter?

Will Revenues increase or decrease as a result of the price cut? By How much?

You calculate that the fixed costs for the Springvale Seaside Caramel are $25,000 per month and each box costs $48 for the labor, candy, packaging and shipping. Will profits go up or down as a result of the price cut? By How much? (Profits are revenue minus all costs.)

Expert Answer

Price Elasticity of demand is an indicator (number) which tells us how demand for a goods in terms of quantity will vary depending on change in price of the product. Usually, when a price of a product is reduced overall demand for the product in the market goes up. This is a case of elasticity of demand.

Elasticity of demand can be either elastic, inelastic or neither. When a large change in price barely changes in quantity of demand, the demand is called INELASTIC. When a moderate change in price, significantly affects demand, the demand is called elastic. Thus, demand can be either Highly elastic or highly elastic depending on sensitivity as mentioned above.

When two factors i.e. price and demand don’t seem to be correlated, we cannot determine elasticity.

Determining elasticity is an important aspect in market research of a product or conducting economic analysis of a market. Elasticity of demand tells us how a demand for a product will fluctuate with change in prices of the product sold by the sellers. This will help the seller to understand overall impact of price changes on the top line and bottom line of the company. For example, Price reduction can increase volume of goods under demand. However, it can reduce total turnover and profit of the company. Alternately, price reduction can increase both volume and revenue of goods sold and yet keep its profit unchanged or lowered.

Such detailed analysis can be conducted if one knows about the price elasticity which helps the firm to strategic pricing decisions accordingly.

Old price per box = $81 per box

Number of boxes sold at old price = 35,000 boxes

Therefore,

Total revenue earned last year = $81 x 35000 = $ 2835,000

New price per box = $73 per box

Number of boxes sold at new price = 37,000

Therefore,

Total revenue earned this year = $ 73 x 37000 = $2701,000

Since,
Total revenue earned this year    < Total revenue earned last year,

REVENUE WILL DECREASE

Decrease in revenue = $ 2835,000 – $2701,000 = $134,000

REVENUE WILL DECREASE AS A RESULT OF PRICE CUT BY $134,000

Total cost last year

= Fixed cost + Total variable cost

= Fixed cost + Variable cost / box x number of boxes sold

= $25,000 + $48 x 35,000

= $25,000 + $1680,000

= $1705,000

Total cost this year

= Fixed cost + Total variable cost

= Fixed cost + Variable cost / box x number of boxes sold

= $25,000 + $48 x 37,000

= $25,000 + $ 1776,000

= $1801,000

Therefore,

Profit last year = Last year revenue – Last year cost = $2835,000 – $1705,000 = $1130,000

Profit this year = This year’s revenue – This year’s cost = $2701,000 – $1801,000 = $900,000

Thus ,

Profit this year < Profit of last year

Profit will go down by = Profit last year – Profit this year = $1130,000 – $900,000 = $230,000

PROFIT WILL GO DOWN BY = $ 230,000
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