When posed the task of applying principles of microeconomics to my everyday life I automatically thought of the business for which I work. I manage a restaurant that makes sandwiches. Recently, the prices of our products have been raised due to rising cost of raw food and an increase in minimum wage. The obvious choice became the Price Elasticity of Demand. In order to calculate the change in price I used the increase in average sandwich price. Due to different sizes, sandwich's, and additions, I thought the average price would most coherently reflect the data instead of calculating different PED in every size, sandwich or addition separately. Also, I compared a month in 2008 to the same month in 2007. This served the purpose of eliminating other variables that effect sales such as weather, holidays, or sports seasons. For example, comparing December, when the public reduces spending (other than on gifts) and weather is poor, to September isn't accurate. Ending this preface the point is all other variables are assumed to remain the same. The quantity sold in a month in 2007 and 2008 was $5.12 and $5.66 respectively. This is an approximate 10.5% price increase, an approximately 20.5% decrease in quantity sold and a PED of about -1.9. This means that the Demand is Elastic and relatively sensitive to price or % decrease in quantity demanded is greater than % increase in price. Conversely, I knew this was not the only factor in decreasing sales.
Not only in the months after the price change but in all of 2008 the sales were significantly less. Due to an economic contraction all businesses have suffered. My next thought was directed to the effect of a decrease in income on the sales. The natural progression is Income Elasticity of Demand. Using the quantities from the months mentioned above (8328 in 2007 & 6626 in 2008), the average income in a year decreased from $42,000 (2007) to $38,000(2008). This gives an income elasticity of 2.15, a positive number indicates that income and quantity demanded have a direct relationship (income and quantity rise & fall together) making the product a normal good. So which change is the prevailing cause of decreasing sales, income or price.
To accurately gauge these effects I analyzed sales in a given month (9571 (2007) & 7666 (2008) which was a month before the price change but the change in income was still present.
The telling fact is that sales were still down 19.9% without the price change. Additionally, the income elasticity calculated using the coinciding month with no change in price the income elasticity in about 2.09 which is very similar to the number in the month with price change. leading me to believe that the income elasticity is the major effect. Because the elasticity formula assumes all variables are constant, if there is a known variable that is not constant I would anticipate a major discrepancy that would distort the income elasticity number to a greater degree. To get an even more accurate description measuring a month with the price change but without an income change, would be useful . However, that data is not available. In spite of this lacking data, I think its fairly obvious that the change in income is the influential factor in decreasing sales.
Saturday, February 28, 2009
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