1. NATIONAL AND KAPODISTRIAN UNIVERSITY OF ATHENS Faculty of Economics Department of Business Economics and Finance Center of Financial Studies Laboratory for Investment Applications Internal Audit Program Course: Managerial Economics and Financial Management - Chapter 5 Instructor: Panayotis Alexakis In cooperation with: Under the aegis of:

2. Managerial Economics and Financial Management Chapter 5: Price Determination in Practice Contents of presentation:  Product pricing in practice  The mark up pricing policy  Current price level and quality of the product  Offer of products at low prices  Other pricing policies  Pricing of a product line  Interdependence of products with respect to the consumption  Interdependence of products in the production process 2

3. Introduction As shown in Chapter 4, the basic assumption in the perfect competition model is that many companies operate, their products are not differentiated at all, while all market participants are fully informed. Both enterprises and consumers know where they can acquire low price materials and low price products, respectively. Prices are fixed for all companies (price takers) formed by the market forces of supply and demand, which in turn represent the cumulative of company / personal behavior. 3

4. Introduction In case demand exceeds supply, equilibrium price will change to a higher level while, in the opposite case, to a lower level. Under this market model, firms that increase the product price above the market level will not be able to sell their products. Also, a reduction in the price by a company is not meaningful, given the company’s very small size in comparison to the market size, as the company can sell all its production at the market price. 4

5. Introduction In the other market models, the difference in the basic assumption lies in the existence of many differentiated products while information is imperfect and characterizes consumer behavior in product choice among competitive companies. Monopolistic competition entails many enterprises which however provide differentiated products. Oligopoly is characterized by a relatively small number of companies whose products are usually significantly differentiated, through a combination of product design, promotion policies and sale points. Monopoly is characterized by one seller while no substitutes exist for the product which therefore is highly differentiated from the products sold by other companies. 5

6. Introduction In contrast to perfect competition, companies active in other market models have the ability to affect market prices (price makers), either upwards or downwards, on the basis of their business objectives. Therefore, the ability of a company to determine the price of its product is linked to its ability to actually differentiate it. Every company can increase its product price up to a certain degree without losing its customers, provided that the customers believe that this product deserves this price. 6

7. Introduction The purpose of managerial economics (in contrast to microeconomic theory) is to deal with the issue of price determination, aiming to answer the following question, “Which is the price level that a firm has to choose in order to achieve its business objectives”? Consequently, it is the model of price determination that should be examined rather than theoretically accepting that prices are given under perfect competition. In practice, a company can face conditions which resemble all market forms. 7

8. Introduction In all examples mentioned which assume certainty conditions, the firm knows both the cost and demand characteristics for its products, accurately. In the same context, if the company’s objective is profit maximization, the price is determined at the point where marginal cost equals marginal revenue. In practice, though, all conditions that were considered as given are not valid for the enterprises. The company has to collect and follow the market data, systematically, both with respect to cost and demand in order to approach the marginal cost and marginal revenue curves and determine the price that satisfies its objectives in the best possible way, under an environment of uncertainty and imperfect information. 8

9. Product pricing in practice Business decisions are not taken autonomously but instead they usually take into account a series of variables which are interdependent, as, for example, the current price of a product, the technology utilised and the organizational structure adopted for the support of production and the sale of a product. The interdependence of the variables which support business decisions creates complex issues to the company. 9

10. Product pricing in practice However, for the determination of the price at the level where the business objectives are attained, the need is for systematic search for information with respect to demand and cost, elasticities, possible reactions by the competitors, and marker shares, among others, which, usually, are unavailable or particularly expensive to be retrieved. Therefore, pricing becomes a difficult and complex task. What economic theory does, is to try and facilitate it by underlying the basic principles of pricing. 10

11. Product pricing in practice However, theory may not always provide practical solutions to pricing problems. Those responsible for the formation of the firm’s pricing policy face the difficult task of selecting market data and analysing them in order to proceed and plan the appropriate methods and pricing mechanisms. The collection of appropriate market data is a particularly cumbersome task, both in terms of time and cost, which explains why, frequently, the pricing methods adopted by the companies are not conducive to the price optimization models suggested by theory. This does not necessarily mean, though, that pricing is not directed by economic theory. 11

12. The mark up pricing policy The mark up pricing policy, according to the analyses of Truett and Truett (1992), Douglas (1987) and Thomson (1985) maintains that a margin is added to the average cost, aiming at covering general expenses and a certain profit. Therefore, the basic variable for the determination of the mark up percentage, refers to the average cost (AC). (1) 12

13. The mark up pricing policy This pricing method is very frequently met in practice. In order for a company to estimate its average cost, it has to calculate both the average variable cost and the average fixed cost. However, since cost is a function of the quantity produced, the company must determine the quantity to be produced. In practice, the determination of the production level is set according to the expected production capacity of the firm, subject to small diversions due to changes to the level of demand. In the following diagram, this cost plus method is presented. 13

14. The mark up pricing policy The method of mark up pricing 14

15. The mark up pricing policy Note: It should be stressed though that, irrespective of the market structure, setting a high product price tends to reduce product demand. Therefore, pricing on the basis of the cost plus method should take into account, not only the cost but also the price elasticity of demand for a product. Also, it should be pointed out that, under this pricing, in case a company produces more than one products, it has been observed that the mark up differs from one product to the other. 15

16. The mark up pricing policy This means that, even if the production cost is linked to the products produced, the company selects different mark up percentages for its products by taking into account the particular demand and cost conditions as well as the competition that characterizes the flow of each product. 16

17. The mark up pricing policy In this process, the company in calculating the mark up percentage, takes into account the demand conditions, indirectly. However, this “cost plus” practice does not integrate the prevailing demand conditions explicitly, as the case is in marginal analysis where the equality condition between marginal revenue and marginal cost is utilised. Therefore, the price determined at the mark up pricing model is differentiated from the price derived through the equalization of marginal revenue with marginal cost. It is only incidentally that they can coincide, to the extent that the mark up percentage is such that leads to the same price with the one that maximizes profits through the marginal approach. 17

18. The mark up pricing policy However, under certain conditions, the “cost plus” technique provides for the ability to approach the price derived by the marginal analysis: According to microeconomic theory MR (marginal revenues) is related to the price elasticity of demand ( ε ). (2) Profit is maximized when MR = MC. Therefore, through substitution. (3) 18

19. The mark up pricing policy In practice, average cost is not differentiated according to the production level, as, usually, steady scale economies prevail and a horizontal average cost curve. So, when the average cost takes the form of a horizontal line, average cost equals marginal cost. In this case relation (3) becomes: (4) And, (5) 19

20. The mark up pricing policy Therefore, (6) Relation (6) is the same with relation (1) of the “cost plus” technique. From (6), it follows that: (7) 20

21. The mark up pricing policy And And since, then (8) 21

22. The mark up pricing policy Therefore, it is derived that the mark up percentage equals the (negative) inverse of one plus the value of the price demand elasticity. So, an inversely proportional relation holds between the mark up percentage and the price demand elasticity. It comes that, for each product, when the price demand elasticity ( ε ) is high, the mark up percentage is low, and the reverse. 22

23. The mark up pricing policy Based on this conclusion, a product characterised by a significant number of substitutes, and therefore a high price elasticity of demand, will be related to a low mark up percentage, as is the case for paper products. On the other hand low price demand elasticity products, such as various kinds of gifts, tend to have high mark up percentages. For a product with a price elasticity of demand of -4, the mark up percentage is 33,3%. If ε =-5, then α =25%. 23

24. The mark up pricing policy Consequently, when accepting that the average cost is not varying with the production level, the case could be that the “cost plus” price formation coincides with that stemming from profit maximization analysis. (Seo 1991, Keat and Young, 1992 The mark up percentage changes in the course of time, following, largely, the changes taking place in the demand and cost conditions. The new price formed under the new mark up percentage should also satisfy the business objectives of the firm. 24

25. The mark up pricing policy So, given that that profit maximization forms the main company objective, this methodology of successive readjustments of the mark up percentage can finally approach the same result derived with the use of marginal analysis, as the company makes use of the relation existing between ε and α, readjusting ( α ) whenever it realizes that ( ε ) has changed. 25

26. The mark up pricing policy As it was shown in (8), From (1), it holds that, Therefore, (9) 26

27. The mark up pricing policy Relationship (9) is useful as it demonstrates the required value of the price demand elasticity in order for an existing mark up percentage to maximize profits. Example: A company producing writing pads, sells them at 2.5 euros, each package of 5 writing pads, 39% above the average cost, which remains steady at 1.8 euros per package. Which elasticity has to be obtained for the mark up percentage to be the one that maximises profits? 27

28. The mark up pricing policy Therefore the demand elasticity with respect to price must be – 3.57 times, in order for the 39% mark up to maximize profits. The company could subsequently analyse whether the mark up percentage is low or high. If it lowers price say, by 10%, it can be seen whether sales increase by 35,7%. If this does not happen and sales increase by a lower rate, say 25%, then the mark up percentage is low and the company will further increase price in order to approach maximum profit. 28

29. The mark up pricing policy In case that companies within a sector follow this practice in product pricing, they can impose the same mark up percentages so that prices change by the same percentage, and no price differentiation is observed. Under these conditions, it is possible, with a great approximation of reality, to foresee, the reactions of the competitor companies following changes in costs and prices. 29

30. Other pricing policies The pricing policy analysed above is determined on the basis of the production cost. Companies, though, under the effect of uncertainty, can also adopt other pricing policies, in practice, in the context of their business strategy and objectives. The pricing policy under uncertainty, beyond the production cost, can also take into account demand, market share and existing competition (Douglas, 1987, Mussa and Rosen, 1978, Lambert, 1980). 30

31. Current price level and quality of the product In the context of a production sector, the current price level is formed as a result of the actions of the participating companies. So, the leading companies can set the price of their product, while they follow the changes in the market and the price elasticity of demand. For the other companies, the current price level forms the basis for the determination of the price of their own product, for which they believe that it is differentiated on certain characteristics, compared to the other products of the sector, and therefore the price that they shall set differs, either higher or lower, from the price of the other products. 31

32. Current price level and quality of the product A significant role in this price formation is played by the consumers’ perception with respect to the existence or not of desired characteristics incorporated to the product. For example, in the television market, one can find many types with different characteristics, such as a flat screen, plasma and LCD, among others. The adding of characteristics provides room for the price margin to move higher for each company. However, when the quality level is similar, prices cannot be differentiated and are expected to approach each other, among the competing companies. As it is obvious, pricing takes into account the quality of the product. 32

33. Current price level and quality of the product Companies endeavour to link in the general picture for their product the existence of uniqueness, aiming, through a higher price, to “convince” the consumer that the product they offer is of high quality. They believe that by setting the price at a higher than the normal level, consumers will realize that the product has a higher quality, as compared to other competitive products, increasing in this way their sales and profits in relation to the case of setting a lower price. In case the consumers cannot easily realize the quality of the product, this policy may prove to be ineffective for a company. 33

34. Current price level and quality of the product On the contrary, when they do realize the quality, they are willing to pay more. For example, for products such as those of high technology, the price reflects consumer evaluation of the quality of the product, as well as for drugs, branded cosmetics, specially designed branded clothes, for which certain consumers are willing to pay a high price. 34

35. Offer of products at low prices Another way of sales promotion, especially for products of elastic demand, refers to the policy that is followed in practice, where price is set at a lower level than the market price, for a given time period. So, a company could aim at increasing its sales and attract new consumers, whose demand will spillover to other products of the company. That is, the formation of a low price for a product from the total product line offered by a company, leads not only to the increase of demand for this product, but also to the rise of demand for all products of the product line, resulting to the increase of total sales and to company profits. 35

36. Offer of products at low prices Durable consumer goods, domestic appliances and similar products, for which repetitive purchases are made, fall into this category. Factors such as the behavior of competitive enterprises and the perception of the consumers on the quality of the product, form significant variables which determine the demand for the product when the price changes. 36

37. Other policies Frequently, a pricing policy is adopted aiming to be linked with a specific business objective of a company, such as the faster repayment of the investment cost and the improvement of the cash flow of a company. The pricing level which succeeds to the attainment of this objective is then adopted and assists the company to face a poor cash flow, especially when frequent market changes take place affecting the demand for the product. For the formation of this price, certain factors are also taken into account, such as the price demand elasticity, the competition facing the product and the maturity of the market, as well as the expected changes in demand. 37

38. Other policies Douglas (1987) asserts that this policy of price differentiation where the bigger is the “size” of a product the smaller is the price per unit of product paid by the consumer, is effective only if the company has the ability to offer the product at a bigger size and to increase its consumer base, since, for the consumer, the additional cost is smaller compared to the additional quantity that he is to acquire. This policy is usually implemented for consumer products, such as food, drinks and cleaning products. 38

39. Other policies Another policy implemented, refers to the offers made by companies in the form of coupons, in this way intervening to the market in order to revitalize the demand for a product, to smooth out seasonal variations in demand, or face the accumulation of high stocks. 39

40. Other policies The choice of the skimming price The skimming price refers to the choice of a relatively high price for a newcoming product to the market, aiming at achieving the higher possible short term profit. In this case, demand is restricted to those buyers who are able and willing to pay a relatively high price. If the time horizon of a company is not very long, then the skimming price maximizes profits. The following diagram presents the price which maximizes company profits. 40

41. Other policies The skimming price for short-term profit maximization 41

42. Other policies  Although this diagram refers to the case of monopoly, it is repeated for stressing two significant points: Firstly, the innovating company functions in practice as a monopoly in the market of the new product, since there is no other company with similar product, at least in the beginning. In the following periods, the entry of competitors with similar products will turn the market into oligopoly, unless this development stops through entry barriers, such as patents owed by the company, lack of resources on the side of the potential competitors, or lack of technology. 42

43. Other policies Also, the skimming price is frequently chosen when the demand for a product is considered as a short – term one and then the consumer is to turn to other products. Secondly, the production capacity of a company could be small in relation to market demand. Since the risk of producing failed products is high, the company may be skeptical in committing resources to construct a bigger production unit or it may not be in a position to proceed to that until the demand size is definitely shown. In this case the company produces beyond the production level that minimizes average cost. 43

44. Other policies In the long term, the company can advance to the construction of a bigger unit and the skimming price could facilitate this expansion. The choice of the skimming price is also appropriate when the company aims at profit maximization in the long run, particularly when important obstacles and costs do not favour the entry of competitor companies, or when the company’s strategy refers to linking the price with the quality of the product. 44

45. Other policies The penetration price The penetration price refers to the practice where a company sets the price of a product at a relatively low level in the current period in order to achieve a broader penetration to the market and secure, subsequently, a bigger market share. Certainly, the maximum penetration can be achieved by selling the product at a price which is linked to a minimum percentage of profitability for the company. In practice, the penetration price is linked to a low mark up percentage which leads to the penetration of the product to the market, and refers to short term sales maximization subject to the achievement of a minimum level of profit. 45

46. Other policies Usefulness: The penetration price is adopted when the company is concerned with the entry of other companies to the sector, with products that are considered as substitutes. Therefore, it discourages competitors from entering the market with substitute products. It is also useful for companies whose time horizon extends beyond the short-term period. 46

47. Other policies Sales maximization subject to the attainment of a minimum profit level must not be considered as incompatible with the maximization of the expected present value of the long term profits. More sales in the short-term, particularly for price elastic demand products, lead to more profits in the long-term, due to larger repetitive sales, larger sales of complementary products and lower probability of entry of other companies, as a result of the lower price.  The determination of prices in practice is not exhausted with the cases referred above, as in reality there are many other methods. The continuous adjustment of the price of a product, throughout its life cycle and the entry price of a new product, form also pricing methods (Alexakis – Xydeas, 1998). 47

48. Pricing of a product line The operation model of a company is differentiated when it comes closer to a modern company, producing a series of products – a product line – in order for the profit maximization objective to be achieved. In the case of a company producing more than one products, these products can be independent among them, that is both the cost and demand for a product are not affected by the other products. Therefore, according to economic theory each product can be produced at the level where its marginal revenue equals its marginal cost. If, however, there is dependence between the products, then the determination of the quantity and the price must take into account specific interdependences, for profit maximization. 48

49. Pricing of a product line Thompson (1985) has determined certain significant cases of product interdependence. a) Product interdependence with respect to demand consumption, for complementary or substitute products, as for example is the case of a certain type of television and its spare parts in the first case and various beverages in the second case. 49

50. Pricing of a product line b) Product interdependence with respect to the production cost. This holds, firstly, for products co-produced in constant proportions with the use of common resources, that is, when, a fixed quantity of resources produces more than one products in constant proportions, and, secondly, when the products are co-produced competing for the limited available quantities of resources, since the production of one product takes place at the expense of the quantity of the remaining products. 50

51. Pricing of a product line Companies have various reasons for producing more than one products. When they are complementary, such as the camera and the film, they are used together and frequently purchased together. The company aims at determining prices at the levels that achieve profit maximization. When the products are substitutes, the companies proceed to their production in order to gain the biggest possible market share and also create, in this way, difficulties to their competitors in entering the market. 51

52. Pricing of a product line In general, the production of a number of different products which, however, share certain common features, forms a preferable policy on the part of the companies to compete one another, mainly in oligopolistic markets. 52

53. Pricing of a product line In particular, for the case of Product interdependence with respect to consumption, on the basis of the mark up pricing practice, the price of each product is chosen using the product’s position in the product line as a criterion and the competition it faces in the market, while the value of the price elasticity of demand is also taken into account. The latter depends on the existence of substitute and complementary products. 53

54. Pricing of a product line a) When the products of the line are complementary, companies usually determine a low mark up for the basic good, in order to achieve a broad penetration to the market and an increase in the sales of the complementary products. b) When the products are substitutes, firstly, the price for the lower quality product of the line is determined in relation to the prices of the products of the competitors in the market. Then, the price for the next product of the line is determined based on the additional qualitative characteristics that it possesses, and on the prices of the competitor companies for almost the same product. 54

55. Pricing of a product line This process continues along the production line, successively, while higher mark ups are determined for products of higher income elasticity of demand. Frequently, the lower quality product is priced at a very low price, in order for the customers to be attracted and become convinced for the advantages of the high quality substitute product of the line. This happens for many durable consumer goods. 55

56. Pricing of a product line A policy frequently met, contributing significantly to sales promotion, refers to the sale of a group or package of two or more products together, as for example a modern television system, the home cinema. However, in order for this policy to be the best possible for the company, it should provide the ability to also offer these products, separately, since certain consumers would wish to pay only for one, say, of these products. It is obvious, though, that the price of each of these products, when sold separately, is higher to that of a group sale, and therefore the value of the group of the products is lower than the cumulative of the separate values of all products. 56

57. Questions 1. In practice, the assumptions that are considered to hold in market models for price determination of a product, are rather not valid. The company by following the market conditions aims at determining the price that satisfies its objectives, in the best possible way. Express your views on these comments. 2. Pricing on a mark up basis takes also into account the price demand elasticity of the product. Comment. 3. How is the pricing policy determined for a company under conditions of uncertainty? 57

58. Questions 4. Under what conditions the skimming price is appropriate for company profit maximization? 5. When is the choice of the penetration price the appropriate policy for a company? 6. Describe cases of interdependence between products produced for the case of pricing a product line. 58

59. Exercises 1. A company selling female clothes buys a quantity of female dresses from a wholesaler by paying 30 euros per dress, irrespective of the quantity of the dresses. These dresses have a mark up of 33,33%, above cost. The objective of the company is to determine the price at a level that achieves the maximum in both covering costs and obtaining profits. The company management is faced with the question, whether the 33,33% markup is the one that maximizes profits. Which is the elasticity of demand that should hold in order for the used mark up to be the optimum one? 59

60. Exercises 2. A company introduced a new product to the market in the first month of the year, which was supported by the relevant advertising campaign and presented a steady rise during the next months. The initial price was set at a level 30% above cost. The objective of the company is to cover its general expenses and maximize profits. Therefore, it examines whether the price of 7.5 euros is the optimum one. Through continuous sales growth, the company undertook market research and derived a price demand elasticity of -3. The sales (tones) and the cost (thousand euros) for the next 3 months, are estimated as follows: 60

61. Exercises JanuaryFebruaryMarch Sales (volume)2,2502,5002,750 Raw materials1,4001,5501,700 Labour3,3504,0504,950 Other Industrial Cost3,0003,0753,150 Management Costs2,150 Electricity – Heating 450 475 300 Other general expenses2,200 61

62. Exercises a) Assuming that the price can be changing, estimate the price per month. b) What is the mark up percentage derived for each month? c) What other possible issues may have to be taken into account, beyond the decision on the price and the sales? 62

63. Exercises 3. A company introduces a new product which depicts unique characteristics. The production director estimated the following average cost (euros) for the product, for the first year and for the other two years. Production level 2,0004,0006,0008,00010,000 1 st year12.5011.7511.5011.712.00 2 nd year10. 00 9.70 9.55 9.50 9.80 3 rd year 9.10 9.00 8.80 8.75 8.85 63

64. Exercises The introduction of the product was accompanied by a large advertising campaign which put emphasis on the unique characteristics of the product. The time for the determination of the price has arrived. The market research undertaken depicted a price demand elasticity of – 4 for the first year, - 3 for the second year and – 2 for the third year. The indications from the market suggest that the demand for the product will be increasing during the first 3 years, and then the entry of competitors with product substitutes will lead to a shift of its demand curve towards the left. 64

65. Exercises Pricing should take into account the management objective for profit and return maximization, in particular following the increased amount spent on advertising and promotion, by the company. a) On the basis of the above information, which is the price that maximizes profits for each of the three years? b) Under what conditions, would you suggest to the company to adopt the policy of the penetration price? 65

66. Exercises 4. Answer the following: a) Derive the formula that provides for the price elasticity for a given mark up rate to be profit maximizing. b) Suppose that body strengthening herbal pills are sold for 1.20 euros per packet, 26% above average variable cost which is at 95 cents per packet. Which is the price elasticity that has to hold if this margin represents the profit maximizing mark up? What does this elasticity imply for this particular case? 66

67. Exercises c) If, due to a price decrease of say 10% sales were to increase by 35%, what would this imply for the above mark up and the price of the product, for profit maximization? 67

68. Solutions to Exercises 68

69. Exercise 1 AC = € 30/ per dress The company, using a mark up percentage a=33,33%, maximizes profits. P = AC + a*AC  mark up policy P=30 + 0.3333*30  P ≈ 40 a = -1 / ( ε +1) The mark up percentage equals negative inverse of one plus the price demand elasticity ( ε ). 69

70. Exercise 1 When ε is high, then the mark up percentage is low, and the inverse. a = -1 / ( ε +1) P = AC + a (AC) a = (P-AC) / AC Then, -1/( ε +1) = (P-AC) / AC ε = [ -AC / (P-AC)] -1 = [-30/(40-30)] – 1 = -4 Meaning: An increase in price by 1%, leads to a reduction to the quantity demanded by 4%. 70

71. Exercise 2 ε P = -3 Formula: AC = Expenses / Sales Expenses (January) = 1,400 + 3,350 + 3,000 + 2,150 + 450 + 2,250 = 12,600 Expenses (February) = 13,500 Expenses (March) = 14,450 For January: AC J = 12,600 / 2,250  AC J = 5.6 For February: AC F = 13,500 / 2,500  AC F = 5.4 For March: AC M = 14,450 / 2,750  AC M = 5.25 71

72. Exercise 2 From the elasticity formula  ε p = [-AC/(P-AC)] – 1, we derive the price per month: P J = 8.4 P F = 8.1 P M = 7.87 72

73. Exercise 2 b) P = AC + a*AC or a=-1 / ( ε +1) January: 8.4 = 5.6 + a*5.6  …  a=50% February: 8.1 = 5.4 + a*5.4  …  a=50% March: 7.87 = 5.25 + a*5.25  …  a=50% 73

74. Exercise 2 c) Other issues: Elasticity with respect to advertising, disposable income, reaction of competitors (when the new products will be launched), among others. 74

75. Exercise 3 Note1: Since it is not defined which production level is to be chosen, alternative combinations can take place. They assist in deriving the most beneficial combination. Note 2: P = (1+a)*AC 75

76. Exercise 3 For the production level of 2,000 units: 1 st Year  a=-1 / ( ε +1) = -1/(-4+1) = 0.33 Then, P = (1+0.33)*12.50 = 16.625 euros 2 nd Year  a= -1 / (-3+1) = 0.5 Then, P = (1+0.5)*10.00 = 15 euros 3 rd Year  a= -1 / (-2+1) = 1 Then, P = (1+1)* 9.10 = 18.2 euros The same process is followed for the remaining production levels. 76

77. Exercise 3 b) Penetration Pricing  A relative low product price during the current period, aiming at a wide penetration of the market and securing, subsequently, a bigger market share. In practice, it is related to a low mark up percentage  short term sales maximization, subject to attaining a minimum level of profitability. It is adopted when the entry of other companies to the sector is taking place, with products which are considered as substitutes. ( ε Pa > 0) 77

78. Exercise 3 It discourages competitors to enter the market with substitute products It is useful for enterprises whose time horizon extends beyond the short-term period. 78

79. Exercise 4 a) Therefore, b) and The price elasticity that has to hold is -4.8. It implies that a, say decline by 10% in the product’s price leads to a rise in demand by 48%. 79

80. Exercise 4 c) When, however, a 10% decrease in price leads to a sales increase by 35%, it implies that ε =-3.5 times. Therefore, both the mark-up and the price have to change, to be increased. or 40%. 80