Economics: Calculation of Elasticities – #265


Question: You are the owner of the Blue Widget Manufacturing Company of Blue Widget Falls, Idaho. You sell your widgets on two markets. The first market is a resale market where you sell your widgets to a packager who then sells widgets not under your brand name. You also sell the “Super Widget”. It slices. It dices. It makes you sexier. It is the perfect Christmas gift. Your only competitor in this market is the Red Widget Manufacturing Company of Red Widget Rapids, Ohio. Red Widget sells to the same packager as you do and sells the “Maxi Widget” which also slices, etc.

Your demand for your “Super Widget” is

Q=1200 – .05 x Po + .03 x Pc + .0004 x I + 2.5 x a
Where Po is your own price, Pc is the Maxi Widget’s cross price, I is the average income of your customers, and a is your advertising budget.

a.) Calculate the income elasticity, own and cross price elasticity for this demand.

b.) Based on this demand equation, forecast your demand for the next five years if income grows at 5% per year and is $10,000 this year, your price goes up by 1% per

year and your current price is $5, and your competitor’s price goes up by 1.5% per year and his current price is $4.

c.) Looking at this equation, what can you do to increase your demand? (Hint: Are there variables in the demand equation that you can change on your own.)

d.) Write down your revenue function. What is your marginal revenue in year one?

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