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Elasticity of pricing | Economics homework help


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Pricing Case




Saco   Atlantic Truffle Case

Understanding   the effects of pricing on revenues, costs and pricing

Introduction: It is April and you have recently been hired   as the manager of Saco Atlantic Truffle Company in Springvale, Maine.    You have been asked to improve profitability.  The company got its name   from a proprietary caramel truffle first sold in a coffee shop also owned by   the Hill family.  Note: Please use Excel for all calculations.

1. (30   points) Analysis of Pricing: You manage The Saco Atlantic Truffle Company   which makes a chocolate – caramel truffle for sale to gift shops from Cape   Cod to Mount Desert Island near Bar Harbor Maine. In 2017, the company sold   individually wrapped candies in boxes of 25 for $51.00 each.  The   candies retail for $4.49 for an individual piece and sales have been   strong.  The owners of Saco 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 70,000 boxes per month from   May through October. Last year they sold 70,000 boxes in May.  So they   run an experiment.  Price is lowered to $46.00 per box in May of this   year and the number of deliveries increases to 75,000. 

a. What is   the Price Elasticity of Demand?

b. Is   elasticity elastic, inelastic or neither?

c. What does   this mean and why does it matter?

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

e. You   calculate that the fixed costs for the Saco Atlantic Truffle are $25,000 per   month and each box costs $25 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.)

2. (30   points) Peter Hill, the 19 year old son of the owner, says that there wasn’t   enough time in the experiment.  He estimates that in the second month,   June, Saco Atlantic Truffle will sell 80,000 boxes at $46.00 per box.    Please answer the following assuming that Peter is correct.  You want to   get an idea of what will happen to profits before you commit to an action and   make a projection. If profits are projected to go up assuming that Peter is   correct, then you will keep the current price of $46.00 during June. If the   profits are projected to go down, you plan to return to $51 per box.

a. What would   be the Price Elasticity of Demand compared to a month ago if Peter is   correct?

b. Is   elasticity elastic, inelastic or neither?

c. What does   this mean and why does it matter?

d. Will   Revenues increase or decrease as a result of the price cut to $46.00 at   80,000 boxes?  By How much?

e. You   calculate that the fixed costs for the Truffles are still $25,000 per month   and total variable costs are $25 for each box. Make a projection of revenues,   costs and profits for June.  Will profits go up or down as a result of   the price cut if Saco Atlantic Truffle Caramel sells 80,000 boxes?  By   How much?

3. (40   points) The Saco Atlantic Truffle owners see the change in profits from the   price decrease in May and the projection for June.  They decide to go   back to a price of $51.00 and have sales of 70,000 boxes in June.     The May production required staff to work 2 weekends and there were   many complaints.  No one wanted to work weekends during vacation season   in Maine and there was no room to expand production.  The owners were   willing to add a second location that would permit greater production if   profits justified.  They decide that they are only willing to manage   enough production to support 70,000 deliveries at a price of $51.00.    However, if they raised price to $60.00 per box for July, they would be   willing to hire additional staff, lease more space across town and produce   118,000 boxes.    

a. Calculate   the Elasticity of Supply.  Is it elastic or inelastic?

b. How many   deliveries will Saco Atlantic Truffle have at a price of $60.00?  Hint:   since the product is perishable, you will only want to produce what customers   will buy.  Use the original the elasticity of demand calculated in #1   above.

c. What will   be the Revenue?

d. What will   be the Profit?

e. Should   Saco Atlantic Truffle raise the price to $60.00? Why or why not?

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