An assignment on

The concept of price elasticity and exchange rate.

Title: Molto Delizioso Case Study

Submitted By

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 Molto Delizioso Case Study 16-12-2020

Introduction

Read and analyze the case study and answer the following questions in 3-4
pages. (Make sure to show all mathematical steps involved).

Case background and overview:

Molto Delizioso is an Italian coffee machine maker that is run in the UK subsidiary of the
company by managing director Nigel Montague. The machines are bought in the
European currency, the Euro, and sold in return in the English market in Pounds.
Customers in the UK are willing to pay 200 pounds per coffee machine. There is fear by
the maker of coffee machines that the new Brexit will affect sales and cause the pound
to be devalued.
What should they do to their profit maximized?
Note:
 Apply the concept of Profit maximization in the case study.
 Apply the concept of price elasticity. Make assumptions about the concept of
price elasticity at 1.1 and 0.8.
 Apply the concept exchange rate. The effect of exchange rate on trade (imports
and exports) when a currency appreciates and depreciates.

Scenarios and assumptions (pre-Brexit and post-Brexit ):

 Post Brexit at the same price (200) pounds (calculate and elaborate)
 Post Brexit price increase to 235 pounds with 0.8 elasticity(calculate and
elaborate)
 Post Brexit price increase to 235 pounds with 1.1 elasticity(calculate and
elaborate)
 Do you have another scenario or assumption in mind?

Summary:
 What will happen if we assume the market is close to perfect competition?
 At what price the profit is maximized?

Recommendations:
 What are your recommendations? Do you increase the price or maintain the
price pre-Brexit? Why?
 Would you increase the price or maintain the price post-Brexit? Why?

Show all the mathematical steps and how you arrived at the conclusion.

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 Molto Delizioso Case Study 16-12-2020

Analysis:

Case-1: Post Brexit at the same price (200) pounds:

Revenue = 200 x 40000 units = 8,000,000 pounds.
Import cost = 90 (cost per unit) x 40000 units = 3,600,000 euros.
Import cost in pounds = 3,600,000 / 1.16 (exchange rate) = 3,103,448 pounds.
Profit = 8,000,000 (revenue) – 3,103,448 (Import cost) – 1,100,000 (other costs)
Profit =3,796,552 pounds
Case-2: Post Brexit price increase to 235 pounds with elasticity being 0.8.
We need to calculate the percentage change in quantity demanded.
Price elasticity = Percentage change in demand / Percent change in price.
The Percent change in price = [(235-200)/200] x100 = 17.5%
Let Percentage change in demand is X %.
0.8 = X / 17.5
X = 0.8 x 17.5
X = 14
So if the price increases by 17.5%, the demand goes down by 14%.
New demand = 40000 x ( 1- 0.14) =34,400 units
Revenue = 235 x 34400 = 8084000 pounds.
Import cost = 90 (cost per unit) x 34400 units = 30,96,000 euros.
Import cost in pounds = 3096,000 / 1.16 (exchange rate) = 26,68,965.517 pounds.
Profit = 8084000 (revenue) – 26,68,965.517 (Import cost) – 1,100,000 (other costs)
Profit =43,15,034.4827 pounds.
Price corresponding to maximum profit:
Price elasticity = % change in demand / % change in price per unit.
If the price is increased from 200 to 201 pounds (0.5% increase), there will be a 0.4%
change in demand for every extra pound.
0.8 = x / .05
X = 0.8 x 0.5

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 Molto Delizioso Case Study 16-12-2020

X = 0.4
So demand goes down by 0.4%
New demand = 40,000 x (1-0.004) = 39,840
So there is a decrease of 160 units for every additional pound. (linear decrease).

Now let the price is increased by Y pounds. So the new demand will be (40000-160Y)
units.
Profit = Revenue – Import Cost – Other Cost
Profit = (40000-160Y) x (200+Y) – [ (90) x (40000-160Y) / 1.16 ] – 1100000
To maximize the profit, we need to differentiate it wrt to Y and equate it to 0.
Differentiating wrt to Y we get:
dP/dY = -160 (200+Y) + (40000-160Y).1 – [ 90 x -160 ] / 1.16 = 0
-32000-160Y+40000-160Y + 12413.793 = 0
320Y = 20413.793
Y= 63.793 or 64
So the price corresponding to maximum profit is 264 pounds.
At this price demand = 29,760.
Maximum Profit =4447674.48 pounds
 The profit is maximized at 264 pounds which will be the optimal price
with a 32% increase in price.
 At that price it will sell 29,760 units. That's a 25.6% decrease in
quantity demanded and the profit actually goes up, So even though it
is selling much less units but makes more profit.
 Sales revenue actually peaks at 225 pounds price per unit but profit
is maximized at 264 Pounds price per unit.
Case-3: Post Brexit price increase to 235 pounds with elasticity being 1.1.
We need to calculate the percentage change in quantity demanded.
Price elasticity = Percentage change in demand / Percent change in price.
The Percent change in price = [(235-200)/200] x100 = 17.5%
Let Percentage change in demand is X %.

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 Molto Delizioso Case Study 16-12-2020

1.1 = X / 17.5
X = 1.1 x 17.5
X = 19.25
So if the price increases by 17.5%, the demand goes down by 19.25 %.
New demand = 40000 x ( 1- 0.1925) =32,300 units
Revenue = 235 x 32300 = 7590500 pounds.
Import cost = 90 (cost per unit) x 32300 units = 2907,000 euros.
Import cost in pounds = 2907000 / 1.16 (exchange rate) = 2506034.4827 pounds.
Profit = 7590500 (revenue) – 2506034.4827 (Import cost) – 1,100,000 (other costs)
Profit =39,84,465.517 pounds
Price corresponding to maximum profit:
Price elasticity = % change in demand / % change in price per unit.
If the price is increased from 200 to 201 pounds (0.5% increase), there will be a 0.4%
change in demand for every extra pound.
1.1 = x / 0.5
X = 1.1 x 0.5
X = 0.55
So demand goes down by 0.55%
New demand = 40,000 x (1-0.0055) = 39,780
So there is a decrease of 220 units for every additional pound. (linear decrease).
Now let the price is increased by Y pounds. So the new demand will be (40000-220Y)
units.
Profit = Revenue – Import Cost – Other Cost
Profit = (40000-220Y) x (200+Y) – [ (90) x (40000-220Y) / 1.16 ] – 1100000
To maximize the profit, we need to differentiate it wrt to Y and equate it to 0.
Differentiating wrt to Y we get:
dP/dY = -220 (200+Y) + (40000-220Y).1 – [ 90 x -220 ] / 1.16 = 0
-44000-220Y+40000-220Y + 17068.96 = 0
440Y = 13068.96
Y= 29.702 or 30

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So the price corresponding to maximum profit is 230 pounds.

At this price demand = 33,400.
Maximum Profit =3990620.689 pounds
 The profit is maximized at 230 pounds which will be the optimal price
with a 15% increase in price.
 At that price it will sell 33,400 units. That's a 16.5% decrease in
quantity demanded and the profit actually goes up, so even though it
is again selling less units but makes more profit.

We can see that if company increases the price to 235 pounds with elasticity
being 0.8 or 1.1, it would be making more profit than it would have if it just kept
the price at 200 pounds.

 Do you have another scenario or assumption in mind?

Case-4: Post Brexit price increase to 235 pounds with elasticity being 1.
We need to calculate the percentage change in quantity demanded.
Price elasticity = Percentage change in demand / Percent change in price.
The Percent change in price = [(235-200)/200] x100 = 17.5%
Let Percentage change in demand is X %.
1 = X / 17.5
X = 1.x 17.5
X = 17.5
So if the price increases by 17.5%, the demand goes down by 17.5 %.
New demand = 40000 x ( 1- 0.175) =33,000 units
Revenue = 235 x 33000 = 7590500 pounds.
Import cost = 90 (cost per unit) x 33000 units = 2970,000 euros.
Import cost in pounds = 2970000 / 1.16 (exchange rate) = 2560344.827pounds.
Profit = 7590500 (revenue) – . 2560344.827 (Import cost) – 1,100,000 (other costs)
Profit =39,30,155.70 pounds.

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 Molto Delizioso Case Study 16-12-2020

Price corresponding to maximum profit:

Price elasticity = % change in demand / % change in price per unit.
Since market is perfectly elastic, so demand goes down by 0.5%
New demand = 40,000 x (1-0.005) = 39,800
So there is a decrease of 200 units for every additional pound. (Linear decrease).
Now let the price is increased by Y pounds. So the new demand will be (40000-220Y)
units.
Profit = Revenue – Import Cost – Other Cost
Profit = (40000-200Y) x (200+Y) – [ (90) x (40000-200Y) / 1.16 ] – 1100000
To maximize the profit, we need to differentiate it wrt to Y and equate it to 0.
Differentiating wrt to Y we get:
dP/dY = -200 (200+Y) + (40000-200Y).1 – [ 90 x -200 ] / 1.16 = 0
-40000-200Y+40000-200Y + 15517.24 = 0
400Y = 15517.24
Y= 39.793 or 39
So the price corresponding to maximum profit is 239 pounds.
At this price demand = 32,200.
Maximum Profit =4097524.13 pounds
However this is considering unitary demand which is not realistic, and hence not
recommended.
Similarly we can calculate the Pre-Brexit Data.
Case-5: Pre-Brexit at 200 pounds price per unit (1 pound = 1.36 Euros)
 Profit = 4,252,941 pounds

Case-6: Pre-Brexit with 0.8 price elasticity

 Profit peaks at 258 pounds price per unit
 Maximum Profit = 4,792,819 pounds.

Case-7: Pre Brexit with 1.1 price elasticity

 Profit peaks at 224 pounds price per unit
 Maximum Profit = 4,379,633 pounds.

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 Molto Delizioso Case Study 16-12-2020

If the company had sold at 258 pounds at 0.8 price elasticity, or the 224 pounds at the

1.1 price elasticity. They actually could have made more profit than they did selling at

200 pounds, and that is considering the exchange rate factor of 1.36 before Brexit.

Summary and Conclusion

The analysis is summarized in the tabular form below:

Profit in Profit in
Pound Price Elasticity Quantity
pounds Euros
Pre-Brexit 1.36 200 - 40000 4252941 5784000

Post-Brexit
1.16 200 - 40000 3796552 4404000
(No change)

Post-Brexit
1.16 235 0.8 34400 4315035 5005441
(Scenario 1)

Post-Brexit
1.16 235 1.1 32300 3984466 4621981
(Scenario 2)

Post-Brexit
1.16 235 1 33000 3930156 4558981
(Scenario 3)

 What will happen if we assume the market is close to perfect competition?

If the market is close to perfect competition, the demand drops to 0 if price is
increased. So no price change is recommended in that case.
 At what price the profit is maximized?
The results corresponding to maximum profit in different cases are summarized
below.
Maximum Profit:

Profit in Profit in
Pound Price Elasticity Quantity
pounds Euros
Pre-Brexit
1.36 258 0.8 30720 4,792,819 6518234
(Scenario 1)

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Pre-Brexit
1.36 224 1.1 34720 4,379,633 5956301
(Scenario 2)

Post-Brexit
1.16 264 0.8 29760 4447675 5159303
(Scenario 1)

Post-Brexit
1.16 230 1.1 33400 3990620 4629119
(Scenario 2)

Post-Brexit
1.16 239 1 32200 4097524 4753128
(Scenario 3)

Recommendations:
 What are your recommendations? Do you increase the price or maintain the

price pre-Brexit? Why?

If the company had sold at 258 pounds with 0.8 price elasticity, or at 224 pounds with

1.1 price elasticity, it could have made more profit than it did selling at 200 pounds. That

is considering the exchange rate of 1.36.

The company made a Profit of 4,252,941 pounds Pre-Brexit at 200 pounds price per

unit (1 pound = 1.36 Euros). However it would have made a Profit of 4,792,819 pounds

if it would have sold at 258 pounds price per unit with price elasticity being 0.8. Similarly

it would have made a Profit of 4,379,633 pounds if it would have sold at 224 pounds

price per unit with price elasticity being 1.1.

The profit is more in case of price elasticity 0.8 but elasticity 1.1 is more realistic and

hence I would recommend increasing the price to 224 pounds per unit before Brexit.

The idea of price elasticity being 0.8 or 1.1 is based on the assumption that market is

not in perfect competition; the company actually do had the capacity to raise the price.

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 Molto Delizioso Case Study 16-12-2020

They would have lost some sales if it did that, but its sales were not going to drop to

zero because it would have retained some of the customers, precisely because its

product was somehow differentiated from everyone else's product.

 Would you increase the price or maintain the price post-Brexit? Why?

Post Brexit, there would be more reason to believe that everyone is going to increase

the prices than pre Brexit. That is the reason that they're contemplating increasing their

prices to begin with. The company would make a Profit of 3796552 pounds Post-Brexit

at 200 pounds price per unit (1 pound = 1.36 Euros). However it would make a Profit of

4447675 pounds if it had sold at 264 pounds price per unit with price elasticity being

0.8. Similarly it would make a Profit of 3990620 pounds if it had sold at 230 pounds

price per unit with price elasticity being 1.1.

The profit is more in case of price elasticity 0.8 but elasticity 1.1 is more realistic Though

the profit and maximum profit, both are higher with price elasticity being 0.8 but the

choice with price elasticity being 1.1 is the more realistic of the two choices, and hence I

would recommend increasing the price to 230 pounds per unit after Brexit.

However, it is recommended that instead of conducting theoretical tests, the

company should conduct market tests of A / B at the price of its coffee machines.

This type of assessment reflects consumers ’actions and their positive actions

predicted by the questionnaire as well as it is simple and inexpensive (Gallo,

2015).

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