Context:
In this week’s discussion you are going to be the CEO of a company. In anticipation of the upcoming quarterly disclosure of profits, you prepare your Board of Directors for the pressure that cost-push inflation is having on profits. There will be some erosion of profits. Please make yourself CEO of only one of these hypothetical companies.
Profile of the Companies
All America Grocery Inc – We serve communities in the middle of the income market providing low prices for all basic grocery needs. Our modest income consumers expect goods deals on good quality foods. The Covid-19 pandemic has put upward pressure on the price of everything we sell. We are also experience rising cost in every aspect of our operation as we have to put extra resources in to protecting both our employees and the public. We are both fortunate and unfortunate that the price elasticity of demand for food is .20.
Very Big US Auto – Very Big US Auto is one of the oldest and one of the largest manufacturers of autos in the US. Very Big US Auto’s supply chain is highly dependent components manufactured in China and assembled in the US, (think back to our week 1 problem with the seat manufacturer). The Chinese economy has rebounded quickly, much of the production capacity is still going to rebuild inventories, so the supply of components still lag behind demand so there is upward pressure on all of our costs. Additionally manufacturing facilities like ours must take extra precaution to keep workers safe. Costs are rising on all aspects of production across the industry. On the demand side, Very Big US Auto knows that demand is relatively elastic with a price elasticity of demand of 1.2. But we also know that pandemic has made some transportation substitutes less acceptable.
Big Time Entertainment – Big Time Entertainment is a nationwide firm providing movies, arcades and other in person entertainment venues such as bowling and roller skating. Our operations have been heavily impacted during the Covid-19 pandemic. On reopening we have been faced with a host of regulations that have greatly increased our cost of operations. We also face uncertainty as to the potential for additional shutdowns. Customers are fearful plus the guidance on operating our facilities means we are operating far below our optimal number of patron to cover the higher cost for cleaning and other measure to protect the public and our employees. Price elasticity of demand is 1.6 and we are also faced with more competitors, online entertainment and gaming, that are not experiencing these cost pressures.
Now explain:
Is the demand curve for your product relatively elastic, inelastic or unitary elastic? Demonstrate for your company’s product, by how much the quantity demanded will change if you pass on a 10% increase in cost. In other words, show your calculation of the percentage change in the quantity demanded if your prices are raised by 10%. You must provide a calculations showing the percentage change in quantity demanded.
Given your company’s price elasticity of demand and the industry supply/competitive environment you face, prepare a statement for your board as to the potential impact on profits. Who will pay the larger share of the cost increases, your firm or your customers?
