# A-AS Level (CIE) Business Studies Paper-3: Specimen Questions with Answers 18 - 19 of 20

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## Case Study-2

Adam, the owner of Ever-Joy Ice-Cream Center, near University Campus, was also a part time student of management studies in a Commerce College. After having studied the theory of price elasticity of demand, he thought that the demand for ice-cream should be price elastic. For an experiment ho announced special-reduced price for the Ever Joy Ice-Cream cone in the second week of August 2001 under the 54th Independence Anniversary Week. He observed the following sales outcome.

 August Price Total Sales Regular I week \$ 5 1000 Special II Week \$ 4 1500

Finding demand elasticity to be much above unity, he inferred that the price reduction led the total sales revenue to increase. This outcome encouraged him to reduce the price in October on permanent basis to ₹ 4.50. To his utter surprise he found that his average weekly sales revenue rather declined to ₹ 4,770.

What happened? Though the average weekly demand had risen to 1060 with the price reduction the sales revenue declined. Because, this time the degree of price elasticity is demand suddenly become price inelastic? Why? What went wrong?

Adam՚s approach to price policy was purely theoretical, assuming all other things being equal. He did not care to look at other factors influencing the demand for ice-cream, such as possibilities like winter, climate adverse effects, similar price-war by the rivals shops in the area. Besides, Adam offered a 20 % price reduction temporarily in August only for a week, so most buyers responded to take the advantage and probably the rival did not retaliate knowing it was a short-term phenomenon at that time. Furthermore, now when the buyers realized that price- reduction in October is permanent, they did not react much on the buying-spree. In the previous case of price reduction, the buyers expected that in future - after the celebration work is over- price will go back to the original level, therefore, they purchased more. This phenomenon of further expectations was also not taken into accounting determining the later price-reduction policy. In short, the business excision of Adam was misled by overestimation of price elasticity from the very short-term data in a special situation rather than resorting to demand estimation based on the long-term sales data under normal circumstances.

From Adam՚s experience, we should learn one important lesson that any judgement based on an aerial view may not always be good. Besides, reality widely differs from theory. Real life is never simple as depicted in theory. Managerial decision making in practice is, therefore, more of an art than science.

## Question 18 (8 of 10 Based on Passage)

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### Write in Short

Show the change in total revenue with the change in price.

### Explanation

According to Marshall easiest way of ascertaining whether demand is elastic is to examine the change in total expenditure of the consumer or the total revenue of the seller.

 Price Total revenue Type of Elasticity 1. Increases2. Decreases ConstantConstant 1. Increases2. Decreases DecreasesIncreases 1. Increases2. Decreases IncreasesDecreases

Thus, from the behavior of the total outlay or total revenue we can infer the kind of price elasticity of demand. In the similar manner from a given price elasticity we can state about the nature of the change in consumer՚s total outlay or seller՚s total revenue.

## Question 19 (9 of 10 Based on Passage)

Edit

### Write in Short

What are the factors influencing elasticity of demand?

### Explanation

When the demand for the commodity is elastic or inelastic will depend on different factors:

• Nature of Commodity: Nature of satisfaction the goods give to the customers are classified into luxury, comfort, necessary goods. Luxury and comfort goods are price elastic and necessary goods are price inelastic
• Availability of substitute: When a close substitute exists, the demand will tend to be elastic. But commodities having no substitute will be somewhat inelastic.
• Number of uses: Goods having single use will have less elastic demand as compared to multi use goods like electricity, coal have a composite demand. With a fall in price these commodities swill be demanded more.
• Income of the consumer: greater is the income, the demand for overall commodities tend to be relatively inelastic. Demand pattern of a millionaire is rarely affected by significant change in price.

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