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Chapter 10: Problem 2

Caterpillar Tractor, one of the largest producers of farm machinery in the world, has hired you to advise it on pricing policy. One of the things the company would like to know is how much a 5-percent increase in price is likely to reduce sales. What would you need to know to help the company with this problem? Explain why these facts are important.

Short Answer

Expert verified
The key elements that are essential to advise the company would be the price elasticity of demand, consumer behaviour, their income levels, substitutes available in the market, retail dynamics, and external factors such as the economic situation. These factors are crucial because they determine how consumers would react to a price increase, they depict their buying behaviour, their sensitivity to price changes, and their ability to switch to substitutes.

Step by step solution

01

Determine Price Elasticity of Demand

This is a critical concept in economics that describes how responsive consumers are to a change in price. One needs statistical data on past prices and quantity sold to calculate this. The formula to calculate the price elasticity of demand is % change in quantity demanded / % change in price.
02

Understand Consumer Behaviour and Market Conditions

For an accurate prediction of sales reduction, we need a clear understanding of consumer behaviour and market conditions. This would include knowing the income levels of the consumers, market competition, substitutes available in the market, consumer preferences, etc. These factors are important in understanding how consumers could potentially react to a price increase. If, for example, there are many substitutes in the market and consumers have a tight budget, a price increase could decrease sales more significantly.
03

Carry out Market Research

If data on past sales and prices are not enough, one might need to conduct market research. This could involve surveys or focus groups to gather more specific data about consumers’ reaction to a price increase and their buying behaviour.
04

Formulate the Prediction

Based on the data collected and analysed in the previous steps, one should then be able to predict the potential effect of a 5-percent price increase on sales. Remember to take into consideration factors such as consumer behaviour, market conditions, and external factors such as the state of the economy, amongst others.

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Most popular questions from this chapter

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