The first task included two questions that required calculations (all the calculations are presented in Appendix 1). The first question of the task was to complete the table about the demand and total revenue using the information provided in the case study. Thus, the price of 20AED was inserted into the demand curve equations for coffee and sandwiches. The results are presented in Table 1 below.
Table 1. Demand and revenue at AED20.
The second question was to explain the terms of economic and accounting profit. In order to compute the accounting profit, production (explicit) costs should be deducted from the total revenue (Hargrave). The economic cost was calculated by subtracting both production and opportunity(implicit) costs from the total revenue (Hargrave). The results are presented in Table 2 below.
Table 2. Current accounting and economic profit.
The economic profit is always lower than the accounting profit, as it includes the implicit costs (Hargrave). In Teena’s case, she fails to make AED8,000 as a teacher because she dedicates her time to the venture. Thus, the economic cost is lower by AED8,000 than the accounting cost, as the implicit costs are not included in the book.
The second question concerned the concept of normal profit and its applications to Teena’s venture. In order to answer the task’s questions, swift research was conducted using Investopedia as the primary source of information. According to Tuovila, a business makes a normal profit when its explicit and implicit costs are equal to the total revenue. In other words, a firm is making a normal profit when the economic profit is equal to zero. In Teena’s case, her venture would be making a normal profit if her monthly revenues were at the level of AED27,200.
Normal profit serves as an indicator of whether the company should stay on the market or exit. If the economic profit is below the normal profit line, the company should consider exiting the market. However, if a venture makes a normal profit, there is no reason for it to exit the market, as it covers all the essential costs and pays all the salaries and bills.
The third task was to calculate the elasticity of demand if Teena decides to increase the price to AED25 for both sandwiches and coffee. In order to complete the task, per cent changes in price and demand had to be calculated using the demand curve equations. After that, the per cent change in demand was divided by per cent change in price (Kenton). The computations are presented in Appendix 2 of the present report. The values for price elasticity of demand are provided in Table 3 below.
Table 3. Price elasticity of demand.
|Price Change||Price Elasticity of Demand|
|Price change of coffee from AED20 to AED25||0.25|
|Price change of sandwiches from AED20 to AED25||1.5|
The fourth task was to explain the concept of price elasticity of demand to Teena to help her make pricing decisions. The task was completed by conducting brief research using Investopedia.
Price elasticity of demand is a financial metric that demonstrates how the demand changes in comparison with the price change (Kenton). It is computed by dividing the per cent change in demand by per cent change in the price of a product (Kenton). The metric helps to make pricing decisions to maximize profits. Some products can be elastic, which implies that a change in price causes a significant change in demand (Kenton). Price elasticity of demand for these products is above 1, and the higher the number is, the more elastic is the product. If the price elasticity of demand is lower than 1, the products are called inelastic, as the change in price has a minor effect on the demand. Gasoline is a common example of inelastic products, as people are likely to be the same amount of gasoline to fulfil their needs regardless of their price (Kenton). However, it is crucial to understand that price elasticity may change depending on the specific price change.
The calculated values for the elasticity of demand can be sued to make the decision about increasing the prices on coffee and sandwiches. First of all, it should be emphasized that Teena needs to make a change in her pricing policy, as her current economic profit is below the normal profit line. This implies that she can gain more profit if she works as a teacher for AED8,000. The calculations demonstrate that Teena should increase the price of coffee to at least AED25, as the product was found inelastic. If Teena increases the price of coffee, total revenues from coffee will increase from AED12,800 to AED15,000 (see Appendix 3). At the same time, Teena should avoid increasing the price of sandwiches due to high elasticity. An increase in price of sandwiches to AED25 will reduce the revenues from the product from AED12,800 to AED10,000 (see Appendix 3). If Teena follows the advise, the economic profit will increase from -AED1,600 to AED600 (see Appendix 3).
The final task was to provide a description of the type of market, in which Teena operates. Teena operates in the coffee shop industry, which experienced rapid growth during the past 20 years. UAE is known to be the most vibrant coffee shop market in the Middle East due to heated competition (“UAE – Coffee Culture”). The market is filled with international players, such as Dunkin Donuts, Costa Coffee, and Starbucks (“UAE – Coffee Culture”). However, the industry experiences a growth of interest to independent coffee shops that retain a strong tradition of coffee preparation (“UAE – Coffee Culture”). Since 88% of local authorities in the coffee shop industry, Teena should not be afraid of competition from “big players” and continue to develop her venture (“UAE – Coffee Culture”). However, she needs to develop her authentic style and use only authentic coffee preparation methods to attract customers, as it is the most successful approach to development among the competitors in the industry.
Hargrave, Marshal. “Economic Profit vs. Accounting: What’s the Difference?” Investopedia, 2020. Web.
Kenton, Will. “Price Elasticity of Demand”. Investopedia, 2020. Web.
Tuovila, Alicia. “Normal Profit”. Investopedia, 2020. Web.
“UAE – Coffee Culture, Trends and Market Dynamics.” World Coffee Portal, 2020. Web.
Appendix 1: Task 1 Calculations
Appendix 2: Task 3 Calculations
Appendix 3: Task 4 Calculations