Decision making is a very important asset in economics. There are many factors that influence decision making. However, in economics, it’s essential for an investor to make informed decisions in order to raise the probability of success in the intended venture. One of the very important factor to consider before introducing a product on the market is as to whether one will be able to get sufficient demand for the intended product line. In the absence of adequate demand it will be difficult to survive on the business given that there are fixed costs such as rent, electricity, wages, etc. that need to be paid irrespective of the revenues raised. It’s thus important that potential investors identify the factors that could influence the demand for the products they intend to introduce into the market. In this case, Schmeck Gut is the firm that is carrying out an analysis of the factors that may influence the demand of Besser energy bar they intend to launch in Atollia. The most crucial data to be corrected is thus the average demand of energy bars per year. This will form our endogenous variable as it’s the one our model will be explaining.
There are three exogenous variables identified to explain the changes in the bars’ average annual demand. These variables are; the average income a person earns in a year, the imports tariff rate for the energy bars, and the number of stores offering the energy bars. This variables will be regressed against the demand for the energy bars to determine the magnitude of impact a change in each can cause the demand to change. The company has also stated the levels at which they can comfortably stand the changes in the given variables. This paper will also analyze the impacts at different given levels.
The following are the economic impacts of the given variables; on the first variable which is changes in income, a growth in income will definitely guarantee an increment in demand for a good depending on the state of necessity and its nature. Income is the revenues that household have which is used in their budget to maximize their utility. Thus income is a very important variable. The second variable which is the import tariff rates could have an impact on demand if there won’t be a sufficient supply of energy bars in the local market thus forcing the supply to be imported from other economies. If the supply will be sufficient in the domestic market, then import tariff rates won’t have a significant impact on demand. Import tariff rate is a cost charged to the importers, it’s mainly meant to prevent excessive importation of goods and services since it can create disincentive in the domestic market. similarly, a rise in import tariff rate could not have a significant impact on demand even if the demand was sources from other countries; it will only reduce the supply and thus there will be an excess demand which again will be good for the business. Even if price rises with respect to the excess demand, the business will still be making a good revenue from selling at higher prices depending on the elasticity of demand for the energy bars. Lastly, the third variable which is the number of store for the energy bars is important as it determines the intensity of competition. The higher the number of stores, the lower the demand for the energy bars since each store will have its own market share. However, if the number of stores happens to be small, the market share for each will be high and thus sufficient demand. High number of store will compete in terms of quantity and not prices since they will fall under competitive markets and will have no market power.
Assuming that import tariffs and inflation rate remain constant, a 1% change is income will result in a very small change in demand or no change at all depending on the distribution of income (Cirera & Masset, 2010). The change in income could easily be directed to buying other goods more necessary than the energy bars. Hence, this might have no or a very small increase in price given that price is determined by the intersection point of supply and demand (Besanko, Braeutigam, & Gibbs, 2011). The following is a possible representation of a 1% increase in income with no change in tariffs and inflation.
The equilibrium point initially is X0, with price P0 and quantity Q0. Since income is not a price factor, if there is an increase in demand, the demand curve shifts outwards. Thus, demand curve shifts from D0 to D1. Since supply is not impacted, the supply curve remains the same but price rise slightly from P0 to P1.
Assuming that import tariffs and inflation rate does not change, a 7% increase in average income will most likely result in a big increase in the demand of energy bars irrespective of the distribution. An increase in demand in the normal case always results in an increase in price level for the commodity. The following is a representation of a probable change in average demand when income rises by 7%.
Again the equilibrium point initially was X0, with price P0 and quantity Q0. The change in income causes a shift in D0 to D1 (Mankiw, 2016). This represents a change in demand from Q0 to Q1. In the short run, since suppliers will not be able to mobilize the resources so as to raise supply, the price level will rise from P0 to P1. In the long run, suppliers will raise their supply since the product is selling at a favorable price. This rise in supply will shift the supply curve rightwards causes price to fall.
The above two graphs represents a change in demand level owing to an increase in price. Since the change in demand is stimulated by a non-price factor, the demand curve must shift outwards. Any shift in demand curve without a corresponding increase in supply curve shift will cause price to rise. Thus, a rise in average income is inflationary. The only advantage in this case is that inflation rate is held constant, otherwise the situation could be different. This case assumes that the rise in price is only for the product that demand rose from an income increase only.
Tariffs are tax the government imposes on the importation of goods from other countries. Thus, tariff increments means that the cost of importation will go up. According to Pettinger (2017) when tariffs increase at a high rate, importation is discouraged. For countries with little importation of goods, the impact from the increased import tariff will be minimal. However for businesses that heavily depend on imports in order to meet the demand for their commodities, the impact will be great. On this analysis, the assumption will be that the good is imported so that the impacts will be observable. The increment in tariff in this case will therefore result in a big decline in importation, thus creating a problem of scarcity of supply.
The initial equilibrium point X0 is at quantity Q0 sold at price P0. The increase in tariff discourages importation and thus supply falls from Q0 to Q1. This is represented by the leftward shift of the supply curve form Supply 1 to Supply 2 curve. A fall in supply results in demand exceeding supply thus resulting in price at which commodities are offered to be higher. The new price P1 is very high. If now average income rises by 1%, automatically it will have no impact on the demand for the products since prices have already gone up. The new equilibrium level will be X1 and consumers will be demanding Q1 at the new price level.
In this case, we assume that income increases by 7% but there is a 10% increase in tariff. First we take it that the tariff has already been increased and then income increases in the presence of the tariff. In this case therefore, the tariff will create a shortage of supply. Then the increase in income will make people to demand more of the good at a shortage making the situation worse, thus, the worse the situation, the higher the price charged. Thus it’s expected that the price will rise further than it rose initially when the shortage was created.
The initial equilibrium quantity Q0 is offered at price P0, making the equilibrium point to be X0. The shortage causes supply curve to shift from supply curve 1 to supply curve 2. This pushes price upward from P0 to P1. The quantity level falls from Q0 to Q1. The new equilibrium is X1. Now at the new equilibrium X1, average income rises by 7%, this enables consumers to demand more of the products, thus, demand rises. The rise in demand is represented by the rightward shift of D0 to D1. However, since there already exist a shortage, the market is unable to supply Q2 which corresponds with equilibrium X2 at price P2. The maximum quantity that the market can supply is still Q1; the shortage quantity. The price corresponding to quantity Q1 and demand curve D1 is P3.
The increase in tariff on imports is discouraging importation thus creating a shortage of supply. The shortage is forcing the suppliers to offer the commodities at a higher price. A small increase in income when there is a high tariff is bringing a better impact on the consumers’ side than a large increase in income. Goods are offered at a lower price when the increase in income is lower but at a very high price when the increase in income is large. However, the two impacts are inflationary.
Conclusion
A higher inflation rate means that the price offered in the market are very high and thus beneficial to the producers. Therefore, producers’ incentive to produce more is raised. In order to produce more, the producers are forced to employ more resources. In this case, the producers will employ more workers. This explains why the unemployment rate falls whenever there is a rise in inflation rate. The relationship between these two macroeconomic variable is explain by using the Philips curve (Forder, 2018).
In the graph above, the initial inflation rate is 2% and the corresponding unemployment rate is 5%. After the inflation rate has gone up by 5%, there is a fall in unemployment rate by 2%. This indicates that the two has a negative relationship such that when one rises, the other one falls. However, higher inflation rate in an economy is beneficial as it stimulates productivity.
A low inflation rate means that goods are either sold at the normal prices or at a reduced prices. This is dependent on the previous record of inflation rate, such that, if inflation rate was higher initially, a fall in inflation rate means that the goods are sold at a lower prices than were sold earlier. Given that there exist some fixed costs that the business has to cater for irrespective of the revenues made from the business. A lower inflation rate creates a disincentive in production. Businesses are forced to lay off some workers since fewer workers can now be able to meet the reduced demand (Keynes, 2018). In this case, the aggregate demand for the goods and services moves down. This is also as a fact that the laid off workers have no income to keep up on demanding for goods and services.
In the above graph, the initial inflation rate is 7%, and the corresponding unemployment rate is 2%. After the inflation rate falls by 3%, the unemployment rate goes up by 4%. The Philips curve again indicates a negative relationship.
Taxation is a cost to businesses charged by the government. It is the source of government revenues. According to Amadeo (2018), the relationship between tax rate fixed by the government and the tax revenue it receives is explained through the Laffer curve. Many economists have advocated for the use of low tax rates to boost the economy. In fact this have been found to work so efficiently. High tax rates have been argued to create a disincentive to production and thus harmful to an economy (Mitchell, 2012). The Laffer curve explains that an increase in tax results in an increased revenue to the government (Riley, 2017). Similarly, a reduction in tax results in government collecting less revenue. However, this is not always true. It reaches a point in time when high tax rates results in government raising less revenues because it discourages investment. At very high tax rate, investors will consider it less profitable to invest and will end up cutting production, consequently laying off some workers. Thus, a high tax rate is most likely to raise unemployment rate. Going back to the Philips curve, a high inflation rate corresponds with low inflation rate. This clearly indicate that the high tax rate will lower the aggregate demand. Below is a representation of Laffer curve together with Philips curve.
The explanation start from the economy being at a 5% tax bracket, T1 tax revenue, 2% unemployment rate and an inflation rate of 7%. As the tax rate rise to 10%, the tax revenue rise from T1 to T2. The rise in tax rate cause inflation rate to fall from 7% to 4%. This reduction in inflation rate corresponds to a 2% increase in unemployment rate.
Lower tax rate is an incentive to increased productivity. Investors will find it attractive to venture into investment since tax is a most important cost to consider before entering into a business. Productivity require more labor and thus unemployment goes up. When unemployment is high, households have income to push up demand thus raising inflation.The explanation start from the economy being at a 10% tax bracket, T1 tax revenue, 4% unemployment rate and an inflation rate of 4%. As the tax rate fall to 5%, the tax revenue reduces from T1 to T2. The cut in tax rate cause inflation rate to rise from 4% to 7%. This reduction in inflation rate corresponds to a 2% decrease in unemployment rate.
The model we are testing is;
Demand for energy bars = + Tariff +
Let Demand = Y, Average income = X1, Tariff = X2 and Number of stores = X3
Such that;
|
Basis |
Income |
Inflation |
Tariff |
|
|
Scenario 1 |
Inflation up |
5% |
5% |
0% |
|
Scenario 2 |
Inflation down |
1% |
2% |
10% |
|
Scenario 3 |
Tax up |
2% |
1% |
10% |
|
Scenario 4 |
Tax down |
3% |
3% |
0% |
Since the changes in inflation are not included in the regression results, it thus not possible to estimate this scenarios. However, economically, it’s expected that in scenario 1, there will be less change in demand since the increase in income is capable of buying more of the product at the current price with no inflation changes. In scenario 2, demand will fall since there is a great discouragement in supply from the 10% tariff. In scenario 3, demand will fall since people will have less income to buy the already high priced good owing to a shortage caused by 10% tariff. In scenario 4, lower tax will raise demand since more people will be employed, income is higher, and thus, demand will rise irrespective of the inflation rise.
The following results are obtained from the excel regression results. The sample size was 20 which is equal to the number of observations. The R Square tells us that average income, imports tariff and the number of store accounts for 93.72% of all the variation in the demand for energy bars while holding all other factors constant (Stephanie, 2014). The Adjusted R Square tells us that average income, imports tariff and the number of store accounts for 92.54% of all variation in demand for energy bars when adjusted for degrees of freedom ceteris paribus.
Our model was
The estimated model is now
This means that; holding average income, tariff and number of stores constant, average demand for bars would still fall be 22.01. For every percent change in income, demand will rise by 0.01. For every percent rise in tariff, demand will fall by 6.62. For every unit change in number of stores, demand will rise by 2.57. The p-value illustrates the overall significance of the variable in the model. Frost (2017) noted that variables with a p-value of 0.05 and below are the most significant. In this case, the income variable is more significant in this model since its p-value is 0.001; tariffs and number of stores are insignificant (Stone et al, 2013).
In the first scenario, if inflation is projected to rise, the board should consider launching the energy bars since the average demand will rise owing to more people being employed. The board could consider the expiring duration of the energy bars, if it’s long enough, the board could consider venturing today, produce more and wait to sell at higher future price. In the second scenario, low inflation rate expectations will discourage demand and thus the board should not consider the launching to avoid producing at a high cost and then selling at a lower future price. In the third scenario, high taxation rate expectations will be bad for the business and thus the product should not be launched. In future, consumers’ income will be reduced by the high tax and they will demand less. Many people will be unemployed and thus less average demand. In the fourth scenario, the board should launch the energy bars if tax is expected to be lower since this means that the economy will be stimulated and average demand will rise. More investment will be carried out and more people will be employed. The answers to this scenarios could have been more informed if the board provided the inflation rate to be analyzed together with the other variables.
Amadeo, K. (2018). The Laffer curve Explains Why Tax Cuts No Longer Work. Retrieved from https://www.thebalance.com/what-is-the-laffer-curve-explanation-3305566.
Besanko, D., Braeutigam, R. R., & Gibbs, M. (2011). Microeconomics. Hoboken, NJ: John Wiley.
Cirera, X., & Masset, E. (2010). Income distribution trends and future food demand. Philosophical Transactions of the Royal Society B: Biological Sciences, 365(1554), 2821-2834. Doi: 10.1098/rstb.2010.0164.
Frost, J. (2017). How to Interpret P-values and Coefficients in Regression Analysis. Retrieved from https://statisticsbyjim.com/regression/interpret-coefficients-p-values-regression/.
Forder, J. (2018). Macroeconomics and the Phillips curve myth. Oxford: Oxford University Press.
Keynes, J. (2018). The general theory of employment, interest, and money. Cham, Switzerland: Palgrave Macmillan.
Mankiw, G. (2016). Principles of Microeconomics .Cengage Learning.
Mitchell, D. (2012). The Laffer Curve Shows that Tax Increases Are a Very Bad Idea — even if they generate More Tax Revenue. Retrieved from https://www.forbes.com/sites/danielmitchell/2012/04/15/the-laffer-curve-shows-that-tax-increases-are-a-very-bad-idea-even-if-they-generate-more-tax-revenue/#6896a62e7e1c
Riley, G. (2017). Laffer curve. Retrieved from https://www.tutor2u.net/economics/reference/laffer-curve.
Pettinger, T. (2017). Effect of tariffs. Retrieved from https://www.economicshelp.org/blog/glossary/tariffs/.
Pettinger, T. (2018). What would Keynes do? How the economists theorists would solve your everyday problems. London: Cassell.
Stephanie. (2014). Excel Regression Analysis Output Explained. Retrieved from https://www.statisticshowto.com/excel-regression-analysis-output-explained/.
Stone, B., Scibilia, B., Pammer, C., Steele, C., & Keller, D. (2013). How to Interpret Regression Analysis Results: P-values and Coefficients. Retrieved from https://blog.minitab.com/blog/adventures-in-statistics-2/how-to-interpret-regression-analysis-results-p-values-and-coefficients.
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