Answer to Question #146593 in Economics of Enterprise for muhammad ammar khan

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.   Because of the promotion offered by ChotooChai , there is an increase in demand for tea products in his market. Promotions give more benefits to customer who then wants to consume more for maximum profit.

Therefore in short run, demand for ChotooChai will increase shifting demand curve to the right. Excess demand will raise the output of tea products in the market.

In long run BaraChai might want to increase their production. Since there is high demand for promotional products, there is also more profit due to increased price. This means BaraChai will give promotional tea products to remain in competitive market. Hence, tea product will attain new equilibrium price due to increase in output and price. Though continued supply might increase quantity of tea which reduces the price (law of supply) of tea product at a time by shifting supply curve to the right and then will attain new equilibrium price. For this case, price will move back to its original level.

B.    Rationing function of price implies that when demand of a product is high compared to its supply, it leads to increase in price and this deters some customer from buying the products. For our case as ChotooChai tea’s demand increases it will increase price due to low supply as shown in the first diagram.

Allocating function of price tells us how scarce resources are allocated. If there is more demand for a product, it induces more producers to allocate their resources to produce that good. For this case, demand for promotional tea will be increased hence BaraChai will also start production of promotional tea products to cater for excess supply in the market as shown in the diagram two.