MANAGERIAL ECONOMICS

CASE- 11 ITCS PRICING PROBLEM

SECTION B

BY GROUP 9 : KUMAR GAURAV (51) KUMARI SNEHA (52) LAKSHAY KOCHHAR (53) KAMIL KHAN (58) NEHA C. PARIHAR (62)

QUESTION : Was the company right in assuming that demand for cigarettes is elastic? ANS 1- Yes, the company was right in assuming that the demand for cigarettes is inelastic due to the following reasons :(1) The Proportion of Consumers Income Spent : An important determinant of the elasticity of demand is how much it accounts for in consumers budget. In other words, the proportion of consumers income spent on a particular commodity also influences the price elasticity of demand for it. The greater the proportion of income spent on a commodity, the greater will be generally its elasticity of demand, and vice versa. The demand for cigarettes tends to be highly inelastic because the individuals spend only a fraction of their income on it. When price of cigarettes rises, it will not make much difference in consumers budget and therefore they will continue to buy almost the same quantity of that commodity and therefore, the demand for them will be inelastic. (2) Habit Formation : Since cigarettes happen to be a habit-forming commodity and consumers are addicted to it, it is another reason as to why the demand for it is highly inelastic and thus, the demand doesnt fall sharply for it even with a slight increase in its price.

(3) The Number of Uses of a Commodity : The greater the number of uses to which a commodity can be put, the greater will be its price elasticity of demand. Since the uses of cigarettes is very specific to smoking, thus , it cant be replaced , and hence, its demand will be inelastic.

QUESTION 2 : Why did the companys policy of hiking prices of cigarettes failed miserably? ANS 2. The companys policy of hiking prices failed miserably mainly due to the following two reasons mentioned below :(a) Time and Elasticity : The element of time also influences the elasticity of demand for a commodity. Demand tends to be more elastic if the time involved is long. This is because consumers can substitute goods in the long run. In the short run, substitution of one commodity by another is not so easy. The longer the period of time, the greater is the ease with which the consumers can substitute one commodity for another. Therefore, initially, the demand for cigarettes didnt fall with the increase in taxation but later with the hike in prices, consumers retorted and the demand for it came down. (b) The Availability of Substitutes : Of all the factors determining price elasticity of demand ,the availability of the number and kinds of substitutes for a commodity is the most important factor. Another reason as to why the policy of hiking prices failed because in the long run, consumers must have looked for alternatives, or substitutes for cigarettes such as bidis , or other tobacco products for their consumption.

QUESTION- Do you think that Government policy of discouraging smoking through excise hike was right? ANS 3. Yes, in our view, the governments policy of discouraging smoking through price hike was right both on the moral grounds and even from the economic point of view as smoking is injurious to health and even if the step doesnt yield immediate results, in the long run, it is sure to discourage smoking at least to some extent, as it will have a negative impact both on the production and consumption of cigarettes.