Answer to Question #146129 in Economics of Enterprise for Syed Qasim

Question

Assume Tea brands ChotooChai and BaraChai are competing brands in the market. With arrival of winter season, ChotooChai announces good promotional deals. Using ‘Comparative Statics Analysis’ of demand and supply model:
a. How will the managements of the two brands study the short-run and long-run impact on Tea Sales, after the announcement of promotions in the market of Tea?
b. Demonstrate and explain, with clearly labelled two panel diagrams, the ‘Rationing Function’ and the Allocating or ‘Guiding Function’ of Price.

Answer 1

a. ChotooChai and BaraChai are two competitive brands of tea in the market. ChotooChai announces promotional deals in winter. Under comparative statics analysis, now we will discuss what impact of this change will happen in the market in the short and long run.

Due to promotional deals offered by ChotooChai, there's an increase in demand for tea products in the market of his tea product. As promotional actions give more benefits to the customer, and they want to consume more for maximum profit.

Thus in the short run, demand for the ChotooChai product will rise, shifting the demand curve to the right. Excess demand, as compared to the supply curve, will raise the output of tea products in the market.

In long run, BaraChai may also want to increase their production. As there is a high demand for promotional products, also there is more profit due to increased price. Hence, he will also give promotions to its tea product to remain in the competitive market. This will lead to an increase in the supply of tea products in the market. Tea products will attain a new equilibrium point by an increase in price and output. But continue supply may also increase the quantity of tea and can reduce the price (law of supply) of tea products in some time by shifting the supply curve to the right and attaining a new equilibrium. In this case, the price will bring back to its original level with an increase in output of tea products.

b. Rationing function of price denotes that when the demand for a product is high as compared to its supply, it leads to an increase in price and also deter some consumers from buying the product. In this case, as ChotooChai tea’s demand increases, it will increase the price due to low supply, as shown in the diagram:

The allocating function of price shows how scarce resources are allocated. If there's more demand for any particular product, it induces more producers to allocate their resources to produce that type of good. In this situation, the demand for promotional tea will be increased and hence BaraChai also will start production promotional tea products to meet the excess supply in the market, as shown in the diagram below.