Cheri Hildreth
EMBA 605
Fall 2015
Homework Assignment #2
- (10 pts.) RJCorman Corp. commissions you to evaluate the economic viability of dinner trains in the central Kentucky region. Since they are the only company capable of setting up and running a dinner train operation, the market demand will be their demand. They have already conducted a demand study and determined that nightly demand on Fridays and Saturdays is given by Q = 300 – 5P, where Q is the number of customers and P is the price of the dinner excursion package in dollars. They have also determined that their marginal costs are constant at $20 per customer (i.e. MC = AVC = $20), and that they incur fixed operational costs of $1000 (TFC = $1000) every time they crank up the locomotive and haul dining cars around the countryside for three or four hours. Is this a losing proposition, or can RJCorman make an economic profit running a dinner train? Obviously you should evaluate the profit-maximizing output and price, and illustrate and explain what profits (or losses) will be earned.
- Nightly demand on Fridays and Saturdays is determined by Q = 300 – 5P,
- Q is the number of customers and P is the price of the dinner excursion package in $$
- Marginal cost (MC) = $20 per customer
- Total fixed costs (TFC)= $1000 for dining car transportation
5P= 300- Q
P= 60 – 0.2 Q
TR= 60Q - 0.2 Q
MR= 60- 0.4 Q
Profit maximizing price and output are found at the point where Marginal Revenue equals Marginal Cost
MR= MC
So : 60 – 0.4Q = 20
40= 0.4 Q
Q= 40/ 0.4 = 100
P= 60 - 0 .2 Q
P= 60 – 0.2x100
P= 40
The profit maximizing price (P) is $40 and the profit maximizing quantity or output (Q) is 100.
For RJ Corman’s dinner train operation:
Total Revenue (TR)= P x Q or TR= 40 x 100= 4,000
Total Cost (TC) = Total fixed cost (TFC) + Total variable cost (TVC)
TC= 1000 + 20 X 100 = 3,000
Profit = TR- TC or 4000 – 3000 = 1,000
RJ Corman is running his dinner train with a positive economic profit!
- (5 pts.) Confirm that the inverse-elasticity pricing rule holds for the profit-maximizing price you calculated in the previous problem. (Hint: use the point elasticity formula: ε = (ΔQ/ΔP)(P/Q) to calculate own-price elasticity of demand.)
ε = (∆Q / ∆P) x ( P/Q)
Q = 300 – 5P
∆Q / ∆P= -5
P/ Q = 40/ 100 = 0.4
So price elasticity of demand ε = -5 X 0.4 = -.2 (inelastic)
Inverse elasticity rule: ( P*-MC)/ P* = 1/ n
(40- 20)/40 = 20/40 = 0.5= 1/n
The inverse pricing rule holds for the profit maximizing price of $40.
- (10 pts.) You own and operate a bar close to the UK campus. After some experimentation, you determine that the typical male patron has the following demand for beer: q = 5 - PB. PB is the price per beer and q is number of beers each male patron chooses to consume on any given visit to your bar. Your costs for beer are MC = AC = $1.
a)What price per beer will maximize profit, how many beers will each patron consume, and what will you earn on each customer? Illustrate in the diagram on the attached sheet.
b)Now, suppose you can charge an entry fee or cover charge to get in the bar. Would you set PB differently? What cover charge would you set? What profits will you earn on each customer? Illustrate in the diagram.
c)Finally, let’s consider how your overall pricing strategy affects the number of customers who come to your bar. Suppose F = 50 - 10CVF and M = 35 + F - 5PB - 2CVM , where F is the number of female customers, M is the number of male customers, CVF is the cover charge for female patrons, and CVM is the cover charge for male patrons. Discuss conceptually (don’t calculate) how you might take these interactions into account in setting the price for beer and the cover charges for males and for females. Why might setting different beer prices for males and for females be problematical?
Female customers are not sensitive to price but are sensitive to cover charge whereas the male customers are sensitive to the price of beer and the number of female customers and the cover charge. Based on the supposition above, If we don’t charge a cover charge for the females then we will have 50 women at the bar and we could charge price for beer equal to the marginal cost. However, based on male sensitivity to price and demand, we can maximize profits by charging them an entry fee and keep beer price at the marginal cost for them too. If we charged different beer prices to our male and female customers, that would be very problematic since there is no practical way to monitor or control the resale of beer in our bar.
- (5 pts.) Using Porter’s five forces model, briefly explain what popped the cork monopoly.
Per the Five Forces model, competition goes beyond the industry rivals and includes four other competitive forces – customers/buyers; suppliers; new entrants to the market and substitute products. In the case of the cork industry that had been dominated by cork producers to manufacture stoppers for wine bottles for centuries, they were taken off guard by “substitute” plastic corks. The plastic corks turned out to be great substitute! Wine makers could switch to plastic since they were able to be manufactured quickly in highly automated factories and the plastic corks wouldn’t cause cork taint. And plastic is a more manageable commodity than cork from a supply chain perspective since it is more easily available than cork which can take up to 20 years to get to the first harvest and then subsequent harvest is limited to once every 9-10 years. Also, manufacturers of some plastic corks print the names and logos of the winery on the bottle stoppers which would be appealing from marketing standpoint. At the time of the WSJ article “How Plastic Popped the Cork Industry”, 20% of the bottle stopper market had been captured by the plastic corks.