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Elasticity of Demand Essay Sample

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Elasticity of Demand Essay Sample

Objective:
a) To apply the concept of elasticity of demand
b) To correlate elasticity with decision making

Part -I
President Mr. Chatterjee of Indian Institute of Business Economics (IIBE), India is concerned about the financial state of his institution. Last year there was a loss of Rs.1.5 million and the trustees are getting restless. Currently there are 1000 full-time students, out of that 700 are degree students from India and 300 students are the from abroad. The present level of fees, including tuition, room and board, is Rs. 1,80,000 for domestic and Rs. 2,00,000 for foreign students per year. Mr. Chatterjee is proposing a 10% increase for next year. On the basis of past experience he has estimated that the price elasticity of demand for domestic students is -1.2 and for foreign students is -1.6. He is particularly worried about the effect of the fee increase. Mr. Chatterjee is also considering a change in promotional expenditure. This currently amounts to 2% of total revenues and it is estimated that the promotional elasticity of demand is 0.1. It is also estimated that variable costs per student are Rs.60,000. Questions

1. Why might Mr. Chatterjee’s estimates of the relevant price elasticity not be very reliable?
2. Estimate the effect of the proposed fee increase on the number of Indian student and revenues from these students, stating any relevant assumptions.
3. Estimate the effect of the proposed fee increase on the total number of students and on total revenues.
4. Estimate how much would have to be spent on promotion to restore revenues to their current level after the increase in fees.
5. Compare the level of profit after the fee change, both with and without the change in promotion, with the current situation.

Part -II
Even when the increase in fees is combined with the increase in promotional spending, Mr. Chatterjee realizes that IIBE still cannot make a profit. He therefore plans a cost-cutting program. Tuition costs amount to 10% of total variable costs (TVC) and he proposes that the variable cost can be reduced by increasing average class size from 15 to 18 students. The reduction in the total number of students means that he can reduce the fixed costs related to accommodation by 20% . The fixed cost related to accommodation was found 5% of TFC.

Re-written by Prof. B Datta

Questions
1. Estimate the cost function of IIBE after the increase in fees and promotion but before the cost-cutting programme.
2. Estimate the cost function of IIBE after the cost-cutting programme.
3. Estimate the break-even outputs before and after the cost-cutting programme
4. Estimate the profit after the programme.

Hints:

Use the principle of Price elasticity and promotional elasticity Total cost = Fixed cost + Variable cost
Total profit = Total revenue – Total cost
Use the concept of break even analysis (as discussed in Financial Accounting)

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