Question

Suppose that you are a business consultant for Trade Kings. You are tasked to assess the impact of increase in advertising budget and increase in price at the same time on total revenue using the following three important pieces of information:

(a) The company is expected to sell K100 thousand worth of the product.

(b) It is estimated that a 1% increase in the advertising budget would increase the quantity sold by 0.35%.

(c) It is also estimated that a 1% increase in the product's price would reduce quantity sold by 0.25%.

By how much total revenue increases/decreases?

Suppose a study found that the price elasticity of demand for cigarettes in Zambia is -0.4. If a pack of cigarettes currently costs K8 and the government wants to reduce smoking by 20 percent,

1. By how much should the government increase the price?
2. What will be the new price level?

Answer 1

1) Expected to sell K100 thousand worth of a product.

1% increase in price as well as advertising budget will raise 0.35% - 0.25% = 0.1% of quantity sold which means quantity sold now is 100.1% of previosuly sold quantity. Price is 101% of its previous price.

Total Revenue = Price * Quantity = 1.001Q * 1.01P = 1.01101PQ which means there is 1.101% change in total revnue. Worth of the product would be K100 * 1.01101 = K101.101

2) Price elasticity of demand = -0.4

Cost of pack of cigarette = K8

Government wants to reduce smoking by 20%

a) Elasticity of demand = %change in quantity demanded / %change in price

-0.4 = 0.2 / %change in price

%change in price = 0.5 = 50%

It means that to reduce smoking by 20%, price must rise by 50%.

b) New price would be K8 * 1.5 = K12