"Micro Economics is the study of particular firms, particular households, individual prices,

wages, incomes, individual industries, particular commodities" Micro means small. Micro
Economics deals with the behaviour of individual variables such as a household, worker,
firm, industry etc.

Macro-Economics

Macro means large or aggregate or total. It is the study of aggregates covering the entire
economy such as total employment, national income, national output, total investment, total
savings, total consumption, aggregate supply, aggregate demand, general price level etc.

Parameters Microeconomics Macroeconomics

of Differentiation
Meaning It studies the particular market Macroeconomics studies the whole
segment of the economy economy, that covers several market
segments
Deals with Microeconomics deals with Macroeconomics deals with various
various issues like demand, issues like national income,
supply, factor pricing, product distribution, employment, general
pricing, economic welfare, price level, money, etc
production, consumption, etc.
Business Applied to internal issues Environment and external issues
Application
Scope Covers several issues like demand, Covers several issues like distribution,
supply, factor pricing, product national income, employment, money,
pricing, economic welfare, general price level, etc.
production, consumption, etc.
Significance Useful in regulating the prices of a Perpetuates firmness in the broad price
product alongside the prices of level and solves the major issues of the
factors of production (labour, land, economy like deflation, inflation,
entrepreneur, capital, etc) within rising prices (reflation),
the economy unemployment and poverty as a whole

Basic Concepts
Every science has its language. Economics has its language. Certain terms are used in a
special sense in economics. So we must understand the meaning of some basic concepts like
wealth, goods, income, value, price, and market. If we do not understand their meaning
properly, it may result in a lot of confusion.
Utility - Capacity of a commodity to satisfy human wants or want satisfying power.

Value–worth. two approaches, 'value-in-use' and 'value in exchange

 Value-in-use – sunshine has immense usefulness but is a free good.

 Value-in-exchange - worth of a commodity or a service expressed in money (price) –

economic good. Water -Diamond Paradox of values

Xx

Goods and services

Services are intangible; they are neither manufactured, transported nor stocked. Services
cannot be stored for future use hence they are produced and consumed simultaneously.
Business services are those services that help in the successful running of the business. They
are intangible, heterogeneous, inseparable, inconsistent, perishable in nature, and require
consumer participation. A service is an act of performance that one party can offer to another
that is essentially intangible and does not result in the ownership of anything. Its production
may or may not be tied to a physical product
Wealth

In ordinary speech, when we refer to wealth, we mean money. But in economics, it has a
special meaning. It refers to those scarce goods which satisfy our wants and which have a
monetary value. We may consider anything that has monetary value as wealth in economics.

All economic goods have value in exchange. So wealth includes all economic goods. Wealth
has been defined as a 'stock of goods existing at a given time that have money value'.

Characteristics of Wealth

(1) It must possess utility. It must have the power to satisfy a want. As Marshall says 'they
must be desirable'.

(2) It must be limited in supply. For example, air and sunshine are essential for life. We
cannot live without them. But we do not consider them as wealth because they are available in
large quantities. Such goods are known as free goods.

(3) Wealth should be transferable. That is, it should be possible for us to transfer ownership
from one person to another.

(4) It must have a monetary value.

(5) It may be external. For example, the goodwill of a company is external wealth.

Utility, scarcity, and transferability are thus important characteristics of wealth.

 Classification of Wealth: Wealth may be classified into a) personal wealth (individual
wealth) b) social wealth (collective wealth), c) national wealth (a + b), and d) cosmopolitan
wealth (e.g. ocean).

Wealth - anything that has market value and can be exchanged for money, a commodity must
possess the following characteristics: i) Utility ii) Scarcity iii) Transferability iv) Externality.

Physical transferability and Notional Transferability (ownership transfer of flat or land).

Digital goods

Economic activity: Four types include production, distribution, exchange, and consumption.

Four Factors of production

Factor Meaning

Land (rent) Any natural resource that is available on, above, and below the surface of
the earth. minerals, soil, water; air, sunshine, and wind. Land earns ‘rent’ in
productive activity.
Labour Any physical or mental efforts undergone during the process of production.
(wages) the reward of 'wages'. e.g. carpenter, accountant, engineer,
Capital Capital is a produced means for further production. It is a man-made factor
(interest) of production that earns the reward in the form of ‘interest’, e.g. machinery,
technology, factory building, etc.
Entrepreneur Organizes the business and gets the work done by others.
(profit)
Xx

Economic Growth and development

Economic growth can be referred to as the increase that is witnessed in the monetary value of
all the goods and services produced in the economy during a period. It is a type of
quantitative measure that reflects the potential increase in the number of business transactions
taking place in the economy.

It can be measured in terms of the increase in the aggregate market value of additional goods
and services produced by using economic concepts such as GDP and GNP.

Economic growth is a narrow concept when compared to economic development.

What is Economic Development?

Economic development refers to the process by which the overall health, well-being, and
academic level of the general population of a nation improve. It also refers to the improved
production volume due to the advancements in technology.
The HDI is a summary composite measure of a country's average achievements in three basic
aspects of human development: health, knowledge, and standard of living. It is a measure of a
country's average achievements in three dimensions of human development:

 a long and healthy life, as measured by life expectancy at birth;

 knowledge, as measured by mean years of schooling and expected years of schooling;

and

 a decent standard of living, as measured by GNI per capita in PPP terms in US$.

The HDI sets a minimum and a maximum for each dimension, called "goalposts", then shows
where each country stands concerning these goalposts. This is expressed as a value between 0
and 1. The higher a country's human development, the higher its HDI value.

It is the qualitative improvement in the life of the citizens of a country and is most
appropriately determined by the Human Development Index (HDI). The overall development
of a country is based on many parameters such as the creation of job opportunities,
technological advancements, the standard of living, living conditions, per capita income,
quality of life, improvement in self-esteem needs, GDP, industrial and infrastructural
development, etc.

Economic Growth Economic Development

Definition It refers to the increase in the It refers to the overall development of the
monetary growth of a nation in a quality of life in a nation, which includes
particular period. economic growth.
Span It is a narrower concept than that of It is a broader concept than that of
economic development. economic growth.
Scope It is a uni-dimensional approach It is a multi-dimensional approach that
that deals with the economic looks into the income as well as the
growth of a nation. quality of life of a nation.
Short-term process Long-term process
Measurement Quantitative Both quantitative and qualitative
Applicable to Developed economies Developing economies
Government It is an automatic process that may It requires intervention from the
Support or may not require intervention government as all the developmental
from the government policies are formed by the government
Kind of Quantitative changes Quantitative as well as qualitative changes
changes
Examples GDP, GNP HDI, per capita Income, industrial
development

Xx
 Economic Growth
Economic growth means an increase in
the real national income of the country.
It is a narrower and more quantitative
dimension concept.
It is a uni-dimensional approach that deals
with the economic growth of a nation.
Economic growth is possible without
economic development (gulf oil counties)
Short-term process
Economic growth is spontaneous and
reversible. It is an automatic process that
may or may not require intervention from
the government. Quantitative changes
Economic growth is measured in terms of
national income and per capita income
Characteristics of wants
 Wants are unlimited
 Wants are recurring in nature
 Wants to differ with age/gender/ preferences
 Wants differ with seasons
 Wants differ due to culture
Classification of wants
 Economic (payment) and non-economic wants
 Individual Wants and Collective wants
 Necessities, Comforts (furniture, pressure cooker) and Luxuries (pleasure and enjoyment, e.g.
AC/ BMW car),
Economic Development
Economic development indicates economic growth
plus progressive changes in certain important
variables which determine the well-being of the
people.
It is a broader concept inclusive of economic growth
and focuses on the qualitative aspect. Both
quantitative and qualitative.
It is a multi-dimensional approach that looks into the
income as well as the quality of life of a nation.
Economic development is not possible without
economic growth.
Long-term process
Economic development is deliberate and irreversible.
It requires intervention from the government as all the
developmental policies are formed by the government.
Quantitative as well as qualitative changes
Economic development is measured in terms of
agricultural productivity, industrial productivity
quality of human life, etc. HDI, per capita Income,
industrial development
Goods and Services - Anything that satisfies human wants, Tangible (goods) and Services –
intangible (Teaching)

Elaborate on the concept of utility.

What Is Utility?

The utility definition in economics is derived from the concept of usefulness. An economic
good yields utility to the extent to which it's useful for satisfying a consumer’s wants or
needs.

Utility is a term in economics that refers to the total satisfaction received from consuming a
good (eating ice cream) or service. Economic theories based on rational choice usually
assume that consumers will strive to maximize their utility. The economic utility of a good or
service is important to understand, because it directly influences the demand, and therefore
price, of that good or service. In practice, a consumer's utility is impossible to measure and
quantify. However, some economists believe that they can indirectly estimate what is the
utility of an economic good or service by employing various models.

Because the first available units of any economic good will be put to the most highly valued
uses, and subsequent units go to lower-valued uses, this ordinal theory of utility is useful for
explaining the law of diminishing marginal utility and fundamental economic laws of supply
and demand.

Nonprice determinants of demand include any factor that causes the demand curve to shift.
They are (1) tastes and preferences, (2) income, (3) prices of substitutes and complements,
(4) number of buyers, and (5) future expectations of buyers about product price.
Demand is a desire for a good backed by ability as well as the willingness to pay. Important
elements
1. desire for a good
2. ability to pay
3 .willingness to spend the money
4. at a certain price
5. at a certain time
It is a quantity demanded that a consumer is ready to buy at a certain price and at a certain
time.
Determinants
1. Price – negative relationship
2. Price of related goods – substitute and complementary goods
3. Income (y) normal goods, demand increases with income, inferior goods demand decreases
 4. Size of population
5. Season – summer icecream, winter – woolen clothes
6. The future expectation of price – marriage season – gold prices to increases, therefore demand
in the preceding period may increase.
Exceptions
1. Geffen goods/ inferior goods
2. Necessary goods – salt, medicine
3. Status goods
4. Change in future expectations
Economic activity can be divided into five main sectors. These sectors are known as the
primary sector (raw materials), the secondary sector (manufacturing), the tertiary sector
(services), the quaternary sector (information services), and the quinary sector (human
services)

GDP composition

Agriculture and allied activities Industry Service sector Total

20% 26% 54% 100%

The quaternary activities which are knowledge-oriented are called quaternary activities.
These mainly include the collection, production, and circulation of information. The
quaternary activities may be seen as advanced services involving specialized technical skills
and knowledge.

Although both sectors provide services, the main difference between the tertiary and
quaternary sectors is that the services provided in the quaternary sector are intellectual
rather than repetitive activities. This difference gives a notion of what the sector is about.
However, this difference is difficult to establish in the real world.

Characteristics of the quaternary sector:

 Since quaternary services involve highly-skilled people, these are led by big companies and
developed countries
 This sector is highly capital and research-intensive.
 The quaternary sector focuses on building itself more and collectively works with other
sectors of the economy and enhances its position in the economy.
 The quaternary sector is believed to disturb the working of many labour markets.
Examples of quaternary industries or sectors:

Financial planning, information generation, consultancy, information technologies, designing,

and research and development are some industries in the quaternary sector. Other activities
that belong to this sector, according to some interpretations, our- government, culture, media,
and the entertainment industry.

Some examples of quaternary services or products are- autonomous vehicles, artificial

intelligence, 3D printing, big data, the internet of things, quantum computing, robotics, and
nanotechnology.

In the modern economy, the analysis and dissemination of information are important enough
to demand a different sector and differently skilled people. The people involved in the
quaternary activities are often referred to as the “Gold Collars”. This is so because this sector
includes highly paid and skilled people in various activities.

These activities consist of-

 People in information-based services such as information-generation and information-

sharing
 People in information technology such as research and development and media
 People in knowledge-based services such as financial planning, designing,
consultation, education, blogging, etc.
 Also, some other definitions of quaternary activities mention them as “pure services”.
So they also include the entertainment sector, for example, to describe government,
culture, and media.
Quinary sector

Quinary economic activities involve work related to administrative character. Senior

business executives, government officials, scientists, judges, etc. belong to quinary
activities. The main difference between the two types is that the people involved in
quinary activities are involved in the highest levels of decision-making or policy-making.

Demand refers to the quantities that people are or would be willing to buy at different prices
during a given period, assuming that other factors affecting these quantities remain the same.
It is worth noting that this definition incorporates three important concepts:

1 It involves three parameters – price, quantity, and time.

2 It refers to quantities in the plural, therefore a whole relationship, not a single quantity.
3 It involves the ceteris paribus (other things being equal) assumption, which is a very
common one in making statements in economics.

Individual and market demand

Price schedule
Household Quantity demanded
Price A B C Market total
10 50 40 30 120
20 40 30 25 95
30 30 20 20 70
40 20 10 15 45
50 10 5 10 25

Demand equation
Linear

Q=a+bP=180−2 P

Q=a+bP+ cY =180−2 P+0.005 I

the value of c represents the marginal effect of Y (income) on Q.

b and other coefficients of variables are elasticities.

For every 1 percent P increases Q increases by b percent (again b is negative).

The value of a represents the maximum sales that will occur if the price is zero. While this
interpretation has limited practical application, the interpretation of b is of much greater
practical importance. It represents the marginal effect of price on quantity demanded. This
means that for every unit the price rises, the quantity demanded will rise by b units.

Power form
b c
Q=a P Y

The values of b and c represent elasticities; more specifically, b represents the price elasticity
of demand, and c represents the income elasticity of demand. In the case of the price
elasticity of demand this means that for every 1 percent, the price rises the quantity demanded
will rise by b percent. In the case of the income elasticity of demand, this means that for
every 1 percent of the income rises the quantity demanded will rise by c percent.

b and other coefficients of variables are marginal effects.

For every 1 unit P increases Q increases by b units (b is normally negative).

We can also compare and contrast the interpretations of the linear and power forms of the
demand equation in the following way:

Linear – constant marginal effects, varying elasticities

Power – varying marginal effects, constant elasticities

Demand and revenue

The demand curve for a firm automatically determines its revenue function, since revenue is
simply price multiplied by quantity.

P = 180 - 2 Q

R = P Q = (180 - 2 Q)Q = 180 Q−2 Q2

Marginal revenue

dR
MR ¿ =180−4 Q
dQ

Elasticity in general terms is concerned with the responsiveness of one variable to changes in
another.

PED (Price Elasticity of Demand) is the percentage change in quantity demanded in response
to a 1 percent change in price. In symbols, we can write

∆Q
%∆Q Q
e p= = (Point elasticity)
%∆ P ∆ P
P

∂Q P
e p= ×
∂P Q

∂ Q P1 + P2
e p= × (arc/ Adjusted elasticity)
∂ P Q1 +Q2

The elasticity of the power form equation is

∂Q P P
e p= × =b a Pb−1 × =b
∂P Q a Pb

ep Demand Interpretation
¿1 Elastic Consumers responsive to price changes
¿1 inelastic Consumers are not very responsive to price changes
¿1 Unit elastic Intermediate case
¿∞ Perfectly elastic Infinitely responsive (buy nothing if the price rises)
 ¿0 Perfectly inelastic Totally unresponsive (buy the same if the price rises)
Important elasticities

Air ticket Coffee Instant Coffee Electricity Furniture Bread

Regular
e p 1.3 0.16 0.72 0.13 3.0 0.09

Income elasticity (YED) is defined as the percentage change in quantity demanded in

response to a 1 percent change in income.

∆Q
%∆Q Q
eY = =
%∆Y ∆Y
Y

eY Demand Interpretation
¿1 Income Elastic Luxury products
0 ¿ e Y <1 Income inelastic Staple products
¿0 Negative elasticity Inferior products
xx

Air ticket Coffee Instant Alcohol Clothing Bread Tea

eY 1.4 0 1.54 1.5 -0.25 -0.6

Cross-elasticity

This refers to the percentage change in the quantity demanded of one product in response to a
1 percent change in the price of another product. This can be expressed in symbols:

∆ Q P'
CED ¿ ×
∆ P' Q
' '
∆ Q P 1+ P 2
¿ '
×
∆ P Q 1+Q 2

CED can be positive or negative according to whether the other product is a substitute or a
complement. For example, if the price of Pepsi rises, the quantity of Coke demanded should
also rise, as people switch from Pepsi to Coke. Firms want to know the CED for their
products to see what their main competition is and determine strategy accordingly; sometimes
the ‘other products’ involved are in the same product line or product mix of the firm itself.
The Ganesh Cable TV (GCT) has estimated the demand for its service to be
given by the following function:

Q=9.83 P−1.2 A 2.5 Y 1.6 P−1.4

r

where
Q¿monthly sales in units

P¿price of the service in $

A¿promotional expenditure in $’000

Y¿average income of the market in $’000

Pr¿price of ‘home movies’ or related substitute goods

The current price of Midwest is $60, promotional expenditure is $120,000, the average
income is $28,000, and the price of ‘home movies’ is $45.
Indicate whether the following statements are true or false, giving your reasons and making
the necessary corrections.
a. If GCT increases its price this will reduce the number of its customers.
b. If GCT increases its price this will reduce its revenues.
c. People’s expenditure on cable TV service as a proportion of their income will increase
when their income increases.
d. If GCT increases its price this will increase the sales of ‘home movies’.
e. ‘Home movies’ are a substitute for cable TV.
f. A 5 percent increase in income will increase demand by 16 percent.
g. A 10 percent increase in price will reduce demand by 12 percent.
h. Current sales are over a million units a month.
i. The demand curve for Midwest is given by: Q=9.83 P1.2
j. GCT’s sales are more affected by the price of ‘home movies’ than by the price of its
service.
k. If GCT increases its price this will reduce its profit.
Solution
a. True; customers and quantity demanded are synonymous in this case, and there is an
inverse relationship between Q and P, as seen by the negative price elasticity.
b. True; demand is elastic since the PED is greater than 1 in absolute magnitude. Therefore an
increase in price causes a greater than proportional decrease in quantity demanded and a fall
in revenue.
c. True; this is because the YED is greater than 1, indicating that cable TV is a luxury
product. Note that the statement would be false if the goods were a staple. For staples,
although expenditure on
the product increases as income increases, and expenditure as a proportion of income falls
since expenditure rises more slowly than income.
d. False; the two products are complementary, shown by the CED being negative; therefore
an increase in the price of one product will reduce the sales of the other. It appears therefore
that ‘home movies’ is a cable channel.
e. False; the two products are complementary, shown by the CED being negative.
f. False; YED =1.6; therefore using the simple elasticity formula (reasonably accurate for
small changes) the change in demand will be 1.6 x 5%=8%.
g. False; change is 1.2 x10= 12%, but this is a change in quantity demanded, corresponding
to a movement along a demand curve (unlike the previous part of the question, which
involves a shift in the
demand curve).
h. False; current sales are given by
−1.2 2.5 1.6 −1.4 −1.2 2.5 1.6 −1.4
Q=9.83 P A Y Pr =9.83 × 60 ×120 ×28 × 0.45❑ = 11420 units
i. False; the demand curve is given by
−1.2 2.5 1.6 −1.4 −1.2 2.5 1.6 −1.4
Q=9.83 P 120 Y Pr =9.83 × P × 120 × 28 ×0.45❑
−1.2
¿ 1554040 P
j. True; the CED is larger in absolute magnitude than the PED. This is an unusual situation
but arises because of the nature of cable TV service. The service is only a means to an end,
that of receiving certain channels.
k.False; since demand is elastic, a price increase has an unknown effect on profit. More
information would be required.

Marginal effects and elasticity

PK Corp estimates that its demand function is as follows:

Q=150−5.4 P+0.8 A+2.8 Y −1.2 Pr

Q¿ quantity demanded per month (in £1000s)

P¿price of the product in $

A¿ firm’s advertising expenditure (in £’000 per month)

Y¿ per capita disposable income (in £’000) $’000

Pr¿price of competitor products or price of BJ Corp (in £).

a. During the next five years, per capita disposable income is expected to increase by £2,500.
What effect will this have on the firm’s sales?

b. If PK wants to raise its price by enough to offset the effect of the increase in income, by
how much must it raise its price?

c. If PK raises its price by this amount, will it increase or decrease the PED? Explain.

d. What is the relationship between PK and BJ? Explain your answer.

e. If next year PK intends to charge £15 and spend £10,000 per month on promotion, while it
believes per capita income will be £12,000 and BJ’s price will be £3, calculate the income
elasticity of demand. What does this tell you about the nature of PK’s product?

f. What effect would an increase in advertising of £1000 have on profitability, if each

additional unit costs £10 to produce?

Solution

a. Use the marginal effect of income on quantity demanded: ∆ Y =£ 2500

∆Q
=2.8
∆Y

∆ Q=2.8 ∆ Y ¿ 2.8 ×2.5=7 or 7000 unit

b. Use the marginal effect of quantity price demanded: The change in the quantity desired to
neutralize the effect of the income effect (a) -7000 units i.e. ∆ Q=−7000=−7 . Using the
marginal effect of quantity price demanded

∆Q
=−5.4
∆P

−7
=−5.4
∆P

∆ P=¿ £ 1.3

The price increase can be £ 1.3 .

∂Q P P
C. PED e p= × =−5.4 × =¿
∂P Q Q

As P increases and Q stays constant (because of rising income), PED increases in absolute
magnitude, meaning that demand becomes more elastic.

d. The two companies make complementary products because the marginal effect of the price
of BJ on the quantity of PK is negative.
 ∂Q Y
e. YED e Y = ×
∂Y Q

P=¿ 15, A=¿ 10, Y =¿ 12, Pr =3

Q=150−5.4 P+0.8 A+2.8 Y −1.2 Pr

¿ 150−5.4 ×15+0.8 ×10+ 2.8× 12−1.2 x 3

= 150 -81+8 + 33.6 -3.6 =107

∂Q Y 12
eY = × =2.8× =0.31 (staple product)
∂Y Q 107

f. If ∆ A=1, ∆ Q=0.8 ¿ 800 units

∆ R=¿Incremental revenue ¿ P × ∆ Q=¿ 15 × 800 ¿ £12000

It takes £10 to produce a part

∆ C=¿ Additional or incremental cost ¿Cost of production + Advertisement cost

¿ 10 ×800 + 1000

¿ £9000

Net profit = ∆ R - ∆ C=¿ 12000 – 9000 ¿ £3,000

Thus every additional £1,000 spent on advertising increases profit by £3,000.

This problem tests the ability of the student to distinguish between the concepts of marginal
effect and elasticity, and apply each one

accordingly

LAD Enterprises sells mobile phones, currently charging £80 and earning £9,600 per
week. It is considering a price cut of 20 percent to increase its market share,
estimating its PED to be -1.6 (negative).
a. Estimate the effect of the price cut on LAD’s revenue, stating any assumptions.

b. If a competitor responds to the price cut by also reducing its price by 20 percent, estimate
the effect on LAD’s revenue, assuming the CED is 0.8.

c. Compare the profits in (a) and (b) above with the original level of profit.

Solution

R1 9600
P1=¿ £80 R1=¿ £9600 Q 1= = =¿ 120 units
P1 80
P2=¿ £64 ∆ P=16

∂ Q P1 + P2 Q 2−Q 1 P1 + P2 Q 2−120 80+ 64

PED e p=−1.6 e p= × = × = ×
∂ P Q 1 +Q 2 P2−P1 Q 1 +Q 2 64−80 120+Q 2

Q2 −120 80+64
−1.6= ×
64−80 120+Q 2

Q2=172

R2=¿ P2 × Q2 ¿£11008

b. CED = 0.8
' '
∆ Q P 1+ P 2
CED ¿ '
×
∆ P Q 1+Q 2
' '
Given that the competitor has reduced the price by 20%, we have P2=0.8 P1
' ' ' ' ' '
∆ P =¿ P2−P1 ¿ 0.8 P1−P1=−0.2 P1

Q2−¿ Q
P'1 + P'2 Q2−¿172 P'1 +0.8 P'1
CED ¿ × = × ¿¿
1

∆ P' Q1 +Q 2 −0.2 P'1 172+Q2

R2=¿ P2 × Q2 ¿ 64 × 144=£ 9216

c. in (a), R rises, C rises, therefore the effect on profit is uncertain.

in (b), R falls, C rises, therefore profit falls.

This problem illustrates several points:

1 Arc elasticities can be used in a chained sequence where the Q2 from

one calculation becomes the Q1 for the next calculation.

2 The effect of a competitor’s price change can be calculated without

knowing the level of price, as long as the percentage change is known.

3 A price war can often result in lower profit.

Pritti Sprays is a manufacturer of cosmetic products. Its management is currently engaged in

an analysis of the lipsticks produced by the firm, examining the future demand for them.
Market research indicates that advertising expenditure, price, and average income are three
major variables affecting the demand for lipsticks. The advertising elasticity for demand is
estimated to be +1.5, the price elasticity -1.2 and the income elasticity +1.8. In addition, the
following data are available.

Year Sales (units) Advertising expenditure Price Income

202 2,369 £21,000 £6.50 £25,000
1
202 £21,000 £6.50 £27,000
2
202 £24,000 £6.80 £29,000
3

a. Estimate sales for 2022 and 2023.

b. A competitor plans on reducing its price from £6.90 to £6.40 in 2023; assuming the CED is
1.5, how much would Pritti have to spend on advertising to achieve the same rate of growth
of sales as from 2021 to 2022?

Solution

Since the elasticities are given as constants we can use these to calculate the power demand
function
−1.2 1.5 1.8
Q=a P A Y

The data available is for the year 2021, first, we obtain

−1.2 2.5 1.6
2369=a ×6.5 × 21 × 25 where promotion and income are

measured in £’000

a=0.7087

Sales in 2022 ¿ 0.7087 ×6.5−1.2 × 212.5 ×271.6 =¿ 2721 units

Sales in 2023 ¿ 0.7087 ×6.8−1.2 × 242.5 × 291.6=¿ 3581 units

b.

2721−2369
Growth from 2021 to 2022 ¿ × 100=¿ 14.86%
2369

Required sales in 2023 = same as between 2021 to 2022 = 1.1486 x 2721 =3125 units

Now the competitor has entered and therefore, the equation of demand will change requiring
finding a new constant, a.
−1.2 1.5 1.8 1.5
Q=a × P × A ×Y × Pr
The data of the competitor is given for the year 2022 with the selling price of the competitor
of £6.9
−1.2 1.5 1.8 1.5
2721=a× 6.5 ×21 ×27 × ( 6.9 )

a = 0.0391

year 2023
−1.2 1.5 1.8 1.5
3125=0.0391× 6.8 × A ×29 × ( 6.4 )

A1.5 =114.8

A=¿23.627 i.e. A=£ 23627