Question

An entrepreneur has an idea for a new product. As she researches her market she finds that the income elasticity of her consumers to be 4.13. Through market research she finds that two related goods, automobiles and airplanes have cross price elasticities with her product of -0.39 and 0.22 respectively. Finally she finds the price elasticity of demand for her product to be quite inelastic at 0.15. In sentence form, answer the following questions to explain what these values actually mean:

1. What two things does this say about her consumers?

2. Who would she be competing with (i.e. a potential substitute)?

3. What does this say about potential opportunities and threats from automobile and/or airplane manufacturers?

Answer 1

1. The research shows that the income elasticity of her consumers is 4.13, which means that the good that the entrepreneur is willing to produce is a normal good. Normal goods are those goods which demand increases when the income of the consumers' increases. As income elasticity is more than 1 (edy>1), it means that the normal good is income elastic. Income elastic means that when income increases the demand for income-elastic goods rises faster than income. This happens in the case of luxury goods. Given price elasticity of demand is 0.15 (edp<1) we can say that consumers won't be affected with a change in the own-price of that good. From the given data we can conclude that the product which is planned by the entrepreneur is a luxury good.

Briefly, we can say by looking at the above explanation that: a) her consumers have a higher disposable income or greater accumulated wealth than the average. b) the consumers are affluent and they seek brands and want to enjoy a cosy lifestyle irrespective of the prices of that good.

2. Given the cross elasticities of automobiles and airplanes. She will be competing with airplanes. because given the cross elasticity of 0.22, an airplane is a substitute for her product and with cross-price elasticity of -0.39, automobiles is a complementary good.

3. If she launches her product, then with the given data she is sure that high-income group people will purchase her product, that will surely boost the aviation product, as it is a complementary good. But she will have a threat from the airplane industry because they will adopt strategies to lure customers towards them, as the products from airplane industry are a substitute for her product then she will be affected if airplane industry succeeds in luring customers towards the, which will also decrease the demand for aviation. Airplane industry has to adopt non-price strategies to lure customers because her product is price inelastic.