Business & Finance - Financial Markets

Sample Solution

1. Oil Price Change due to Increased Supply

Given:

• Short-run price elasticity of demand for oil = -0.3 (negative because quantity demanded decreases with increasing price)
• Increase in oil quantity = 6%

We need to find:

• Change in oil price

Formula:

Price elasticity of demand (E_d) = (% change in quantity demanded) / (% change in price)

Full Answer Section

Rearrangement:

% change in price = (% change in quantity demanded) / E_d

Calculation:

% change in price = 6% / (-0.3) = -20%

Interpretation:

The price of oil is expected to decrease by 20% in the short run due to the 6% increase in supply. This is because the demand for oil is relatively inelastic in the short run, meaning a change in price doesn't significantly impact the quantity demanded. Therefore, an increase in supply leads to a larger percentage decrease in price to maintain equilibrium in the market.

Note: This is a simplified model and doesn't account for all factors that might influence oil prices, such as geopolitical events or changes in global demand.

2. Honey Bunches of Oats Price Change Impact on Sales

Proposed price change:

• Decrease in price by 4%

Expected impact on sales:

Short run:

• Increase in sales: A lower price makes Honey Bunches of Oats more attractive to consumers, potentially leading to a temporary increase in sales volume. This is especially true if consumers are price-sensitive and perceive the lower price as a good deal.
• Impact on revenue depends on the elasticity of demand: If the demand for Honey Bunches of Oats is elastic (greater than -1), the increase in sales volume may outweigh the decrease in price per unit, leading to an increase in revenue. However, if the demand is inelastic (less than -1), the decrease in price might outweigh the increase in sales volume, leading to a decrease in revenue.

Long run:

• Market share gain: A sustained lower price compared to competitors can attract new customers and increase Honey Bunches of Oats' market share. This is particularly effective if the brand builds on the price reduction with effective marketing and promotional campaigns.
• Competitive response: Competitors might likely react to the lower price by offering discounts or promotions of their own. This could lead to a price war that might erode profit margins for all brands involved.
• Brand image: Lowering the price can potentially harm the brand image of Honey Bunches of Oats, particularly if it's not communicated effectively or associated with lower quality. Conversely, it can also be seen as a value proposition and attract budget-conscious consumers.

Additional factors to consider:

• Price sensitivity of consumers: Understanding how much consumers are influenced by price changes in the cereal market is crucial. Market research can provide valuable insights into the elasticity of demand for Honey Bunches of Oats.
• Competitor activity: Analyzing competitor pricing strategies and potential responses is essential before making a pricing decision.
• Marketing and promotional strategy: Effectively communicating the price reduction and its benefits to consumers alongside targeted marketing campaigns can support the sales increase.

Overall, the impact of lowering the price on Honey Bunches of Oats sales depends on various factors, but a short-term increase in sales volume is likely. The long-term success depends on maintaining a competitive advantage, building brand value, and navigating potential market responses.