Who will pay the larger  share of the cost increases, your firm or your customers?  

Context:

In  this week’s discussion you are going to be the CEO of a company.  In  anticipation of the upcoming quarterly disclosure of profits, you  prepare your Board of Directors for the pressure that cost-push  inflation is having on profits. There will be some erosion of profits.   Please make yourself CEO of only one of these hypothetical companies.

Profile of the Companies

All America Grocery Inc –  We serve communities in the middle of the income market providing low  prices for all basic grocery needs. Our modest income consumers expect  goods deals on good quality foods.  The Covid-19 pandemic has put upward  pressure on the price of everything we sell. We are also experience  rising cost in every aspect of our operation as we have to put extra  resources in to protecting both our employees and the public.  We are  both fortunate and unfortunate that the price elasticity of demand for  food is .20.

Very Big US Auto – Very  Big US Auto is one of the oldest and one of the largest manufacturers  of autos in the US.  Very Big US Auto’s supply chain is highly dependent  components manufactured in China and assembled in the US, (think back  to our week 1 problem with the seat manufacturer).  The Chinese economy  has rebounded quickly, much of the production capacity is still going  to rebuild inventories, so the supply of components still lag behind  demand so there is upward pressure on all of our costs.  Additionally  manufacturing facilities like ours must take extra precaution to keep  workers safe.  Costs are rising on all aspects of production across the  industry.  On the demand side, Very Big US Auto knows that demand is  relatively elastic with a price elasticity of demand of 1.2. But we also  know that pandemic has made some transportation substitutes less  acceptable.

Big Time Entertainment –  Big Time Entertainment is a nationwide firm providing movies, arcades  and other in person entertainment venues such as bowling and roller  skating.  Our operations have been heavily impacted during the Covid-19  pandemic.  On reopening we have been faced with a host of regulations  that have greatly increased our cost of operations. We also face  uncertainty as to the potential for additional shutdowns. Customers are  fearful plus the guidance on operating our facilities means we are  operating far below our optimal number of patron to cover the higher  cost for cleaning and other measure to protect the public and our  employees.  Price elasticity of demand is 1.6 and we are also faced with  more competitors, online entertainment and gaming, that are not  experiencing these cost pressures.

Now explain:

• Is  the demand curve for your product relatively elastic, inelastic or  unitary elastic?  Demonstrate for your company’s product, by how much  the quantity demanded will change if you pass on a 10% increase in  cost. In other words, show your calculation of the percentage change in  the quantity demanded if your prices are raised by 10%. You must provide a calculations showing the percentage change in quantity demanded. 
• Given  your company’s price elasticity of demand and the industry  supply/competitive environment you face, prepare a statement for your  board as to the potential impact on profits.   Who will pay the larger  share of the cost increases, your firm or your customers?