Question: Suppose you are a brash new economist who has just been employed by Renault Motor Corporation. Your first task is to head a sales team in the company. You are involved in heading the sales team that is responsible for the pricing strategy of a new hatchback model, called the VaVaVoom. Market research and detailed forecasting models suggested that a price set around €20,000 would generate European sales of 20,000 cars. After detailed discussions, however, the sales team decides on €19,500 as the initial selling price. At this price 15,000 units of the VaVaVoom model were sold in 2008. This was below the forecasted sales due to a weak buyers market and the onset of recession.

Resultantly, the team decides to drop the price to €18, 500, which is swiftly followed by an increase in sales to 18,000.

(a) Graph the demand curve for VaVaVoom cars.

(b) Using this information derive the demand equation for VaVaVoom cars.

(c) This demand equation contains two variables, one of which is explanatory in nature, Q. Can you now identity the other main factors that should be included in the demand function of the VaVaVoom model support your choices with a suitable explanation in each case.

(d) Calculate two elasticity measures for the above price and quantity information. Interpret your results and suggest the measure that you will use. Why?

Now suppose you know that the Average Cost for the new VaVaVoom model is AC = 10/Q – 3 + 1.2Q.

(e) Calculate the profit maximising price of the new VaVaVoom model. How many units will Renault sell of this model on the European market at this price?

(f) Calculate the level of profit that Renault will earn for selling this model at the profit maximising price.

(g) What is the magnitude of monopoly power possessed by your firm for this product at the profit maximising price and

quantity? Your team now require you to interpret the result and link it to the concept of market power.

(h) Some of your team members query the profit maximising rule and require you to explain it to them. They have no economic background, but are excellent readers of graphs.

(i) Your team are satisfied with your examination of profit maximisation. They now, however explain to you that the success of the team in the eyes of the CEO is based on revenue maximisation and not profit maximisation.

Consequently, they now require you to explain how they could now maximise revenue. Because you were so successful with the graphical approach previously you use this again.

(j) Now, the sales team ask you to calculate the price that Renault should charge for the VaVaVoom model and the resultant quantity of units sold if Renault wishes instead to maximise their revenues from sales. What is the level of profit now earned by the firm?

(k) Suggest reasons why Renault Motor Corporation may wish to maximise revenue rather than maximise profits.