Microeconomics Assignment: Case Analysis of a Business Venture

Question

Task: You have to write a Business Report on microeconomics assignment where you address the following five (5) tasks:

Task 1:
What is the dirham value of the Economic profit and Accounting profit in this case study?. (Computations to arrive at the required result must be shown in the Appendix) Why are the two values different?

Task 2:
Explain to Teena the meaning of “normal profit”. Does she need to exit the market if she is earning a normal profit?

Task 3:
Calculate the elasticity of demand for both coffee and sandwiches when the price changes from AED20 to AED25. Calculations must be in the Appendix.

Task 4:
Explain the concept of price elasticity of demand to Teena and advise her about her pricing strategy for both coffee and sandwiches. Do you think it is a good idea for her to increase the price of both items from AED 20 to AED 25? Justify your answer.

Task 5:
Given the information provided describe the type of market Teena’s coffee shop is operating in. Make sure you explain the features and the behaviour of firms in this type of market.

Answer

Introduction:
This business report on microeconomics assignment intends to analyse the business venture of Teena on the basis of microeconomic concept. Through this report, Teena will understand her profit-making condition by calculating both economic profit, accounting profit and normal profit. Moreover, the concept of price elasticity will also be analysed to understand whether she would charge higher prices for both coffee and sandwiches or not. Along with this, the report will examine and interpret the market structure where Teena is operating her coffee shop business.

Task 1:
For completing task 1, I will consider demand curve for coffee and that of sandwiches to measure total revenue when Teena charges AED 20 per unit for both goods.

The given weekly demand curve for coffee is:
Qd = 200 – 2 x P
Substituting AED 20 with P to get quantity that is demanded in the market:
Q = 200 – 2*20
Q = 200 – 40
Q = 160

To obtain monthly total revenue, the obtained weekly quantity of coffee is multiplied by 4.
Hence, the monthly quantity is 160*4 = 640
Similarly, the given weekly demand curve for sandwiches is:
Qd = 400 – 12 x P
Substituting AED 20 with P to get quantity that is demanded in the market:
Q = 400 – 12*20
Q = 400 – 240
Q = 160

Hence, the monthly quantity is 160*4 = 640
Now, completed table is represented below:

Table 1:

The table below represents the dirham value of the Economic profit and Accounting profit for Teena (see appendix 1 for calculation):

Table 2:
Concept

The value of accounting profit differs from that of economic profit because accounting profit considers only explicit costs while economic profit considers implicit costs as well (Dean et al. 2020).

Task 2:
The second task of the report is to describe the meaning of normal profit to Teena and guide her in taking proper business decision. According to microeconomic concept, normal profit considers both explicit and implicit costs. It can be measured from the formula of economic profit. When the different between total revenue and the combination of explicit and implicit costs of a business becomes zero then it is said that the business gets normal profit only (Orsag and Džidi? 2018). If Teena is earning normal profit then she is capable to meet her total costs of the business. Moreover, by gaining normal profit, she can remain competitive in the market. Thus, she does not need to exit the market if she is earning a normal profit.

Task 3:
The quantity of coffee and sandwiches are already determined from their respective demand curves when price is AED 20.

Now, price of these products becomes AED 25. Thus,
The given weekly demand curve for coffee is:

Qd = 200 – 2 x P
Substituting AED 25 with P to get quantity that is demanded in the market:
Q = 200 – 2*25
Q = 200 – 50
Q = 150

To obtain monthly total revenue, the obtained weekly quantity of coffee is multiplied by 4.
Hence, the monthly quantity is 150*4 = 600
Similarly, the given weekly demand curve for sandwiches is:

Qd = 400 – 12 x P
Substituting AED 25 with P to get quantity that is demanded in the market:
Q = 400 – 12*25
Q = 400 – 300
Q = 100

Hence, the monthly quantity is 100*4 = 400

The calculation of elasticity of demand for both coffee and sandwiches are represented in appendix 2. The following table represents the value of elasticity when price changes from AED 20 to AED 25 for both products.

Task 4:
In task 4, I will explain the concept of price elasticity of demand to Teena and will advise her in pricing strategy. Price elasticity of demand is an economic measure that describes the changing demand for a product when its price changes. Price elasticity can be either elastic or inelastic type depending on the value. When the value of elasticity of a product is more than 1 then it can be said that the product has elastic demand. It means if price increases by 1% then quantity demanded for it will decrease by more than 1% and vice versa. Similarly, when the value of elasticity of a product is less than 1 then it can be said that the product has inelastic demand. It implies that if price increases by 1% then quantity demanded for it will decrease by less than 1% and vice versa (Jawad et al. 2018). Now, from table 3, it is clearly observed that coffee has inelastic demand (0.25<1) and sandwiches have elastic demand (1.5 >1). Thus, Teena can increase price of coffee as it has inelastic demand and hence demand will not fall significantly after increase in its price. However, she cannot increase the price of sandwiches as the product has elastic demand and hence demand will fall significantly after increase in its price.

Task 5:
Coffee and Sandwiches have substitutes in the market. Many sellers sell the same products while many buyers purchase the same. However, as she is not earning normal profit, it cannot be said that the market is perfectly competitive. Moreover, in this market, the seller acts as a price-taker and cannot change the product price (Bertoletti and Etro 2016). However, Teena is deciding to increase the price for both coffees and sandwiches. Thus, from this it can be stated Teena is operating in a monopolistic competitive market where sellers compete with each other but enjoys monopoly power. Here, she can increase or decrease the price of products and the market demand will change accordingly.

References:
Bertoletti, P. and Etro, F., 2016. Preferences, entry, and market structure. The RAND Journal of Economics, 47(4), pp.792-821.

Dean, E., Elardo, J., Green, M., Wilson, B. and Berger, S., 2020. Explicit and Implicit Costs, and Accounting and Economic Profit. Principles of Economics: Scarcity and Social Provisioning (2nd Ed.).

Jawad, M., Lee, J.T., Glantz, S. and Millett, C., 2018. Price elasticity of demand of non-cigarette tobacco products: a systematic review and meta-analysis. Tobacco control, 27(6), pp.689-695.

Orsag, S. and Džidi?, A., 2018. Value added as a measure of economic profit. ActaEconomica, 16(29), pp.9-37.

Appendix:
Appendix 1:
Calculation of accounting profit and economic profit:
To calculate accounting profit, total revenue is subtracted from explicit costs.
Here, total revenue of Teena is AED (12800 + 12800) = AED 25600

Explicit Cost = monthly cost of two coffee machines + monthly rent for the café + monthly salary of two students + monthly expenditure on ingredients + other expenditures
Hence, Explicit Cost = (1600 * 2) + 5000 + (3000 * 2) + 4000 + 1000
Explicit Cost = 3200 + 5000 + 6000 + 4000 + 1000
Explicit Cost = 19200

Hence, explicit cost of Teena is AED 19200
The formula of Accounting profit is: Total Revenue – Explicit Cost
Thus, Accounting profit is AED 6400
To obtain economic profit, accounting profit is subtracted from implicit cost.
Here, implicit cost of Teena is foregone salary that he earned as an art teacher.
Hence, Implicit cost = AED 8000
Thus, economic profit = 6400 – 8000
Economic profit = -1600
Thus, the economic profit is AED -1600

Appendix 2:
Calculation of elasticity of demand for both coffee and sandwiches:
Thus, price elasticity of demand for coffee:
Change in price from AED 20 to AED 25 = (25 – 20) = 5
Change in quantity from 640 to 600 (600 – 640) = -40
Thus, price elasticity of demand = (% change in quantity / % change in price)
Price elasticity of demand = -(40/5) * (20/640) = - 0.25
Thus, the absolute value of Price elasticity of demand for coffee = 0.25%

Thus, price elasticity of demand for sandwiches is:
Change in price from AED 20 to AED 25 = (25 – 20) = 5
Change in quantity from 640 to 400 (400 – 640) = -240
Thus, price elasticity of demand = (% change in quantity / % change in price)
Price elasticity of demand = - (240/5) * (20/640) = -1.5
Thus, the absolute value of Price elasticity of demand for sandwiches is 1.5%