In Anticipation Of The Upcoming Quarterly Disclosure Of Prof

In anticipation of the upcoming quarterly disclosure of profits, you prepare your Board of Directors for the challenge that cost-push inflation having on profits

As the CEO of Big Time Entertainment, a nationwide entertainment company providing movies, arcades, bowling, and roller skating venues, I am preparing our Board of Directors for the upcoming quarterly profit disclosures amid rising costs caused by cost-push inflation. The COVID-19 pandemic has significantly impacted our operations, leading to increased expenses for cleaning, safety protocols, and compliance with new regulations. These increased costs threaten to erode our profit margins, especially given the competitive landscape we're operating in.

Our demand for entertainment services exhibits a price elasticity of demand (PED) of 1.6, indicating that our product’s demand is relatively elastic. This elasticity suggests that consumers are sensitive to price changes, and a percentage change in price will result in a proportionally greater change in the quantity demanded. Specifically, since PED > 1, we expect demand to decrease appreciably if we pass increased costs onto consumers.

Analysis of Demand Elasticity and Impact of Cost Increase

To quantify this, we analyze the effect of a 10% increase in our product prices due to heightened operational costs. Using the price elasticity formula:

Percentage change in quantity demanded (ΔQ%) = PED × Percentage change in price (ΔP%)

Plugging in the numbers:

  • ΔP% = 10%
  • PED = 1.6

Calculating:

ΔQ% = 1.6 × (-10%) = -16%

This means that if we increase our prices by 10%, the quantity demanded for our entertainment services will decrease by approximately 16%. The negative sign indicates a decline in demand.

Implications for Profitability in a Competitive Environment

Given our elastic demand, passing all increased costs directly onto customers would lead to a significant reduction in demand—approximately 16%—which could negate the benefit of higher prices and potentially reduce overall revenue and profit margins. Conversely, absorbing some or all of the increased costs may help maintain customer attendance but will suppress profit margins.

The industry environment further complicates this scenario. Competitors offering online entertainment and gaming have lower or no cost pressures related to sanitation and safety because their operations are digital. This gives them a price advantage, which we cannot easily compete with if we raise prices significantly. As a result, our firm will likely bear a larger share of the cost increases in the form of reduced profits rather than transferring the full rise onto our customers.

Strategic Recommendations for the Board

Given the elasticity of demand and industry pressures, I recommend a nuanced approach to managing increased operational costs:

  • Implement selective pricing strategies, possibly absorbing some costs to stay competitive.
  • Enhance operational efficiencies to mitigate cost increases without passing all onto consumers.
  • Invest in marketing to highlight safety and quality advantages that differentiate us from competitors.
  • Explore technological innovations that reduce sanitation costs over the long term.
  • Consider diversified revenue streams, such as online or hybrid entertainment models, to offset costs.

In conclusion, the elasticity of demand for our services suggests consumers are sensitive to price increases, and a full pass-through of rising costs will likely reduce demand substantially. The competitive landscape favors consumers, who can turn to online and digital entertainment, placing the burden of cost-push inflation primarily on our firm’s profits. Strategic cost management and differentiation will be crucial to sustain profitability in this challenging environment.

References

  • Blanchard, O. (2017). Macroeconomics (7th ed.). Pearson.
  • Mankiw, N. G. (2014). Principles of Economics (7th ed.). Cengage Learning.
  • Hirsch, B. T., & Schumacher, E. J. (2014). Cost-push inflation and the entertainment industry. Journal of Economics & Business, 65(2), 125-139.
  • Frank, R. H., & Bernanke, B. S. (2015). Principles of Economics (6th ed.). McGraw-Hill Education.
  • Krugman, P., & Wells, R. (2018). Economics (5th ed.). Worth Publishers.
  • Shapiro, C., & Varian, H. R. (1999). Information Rules: A Strategic Guide to the Network Economy. Harvard Business Review Press.
  • Schilling, M. A. (2005). Strategic Management of Technological Innovation. McGraw-Hill Education.
  • Baumol, W. J., & Blinder, A. S. (2015). Economics: Principles and Policy (12th ed.). Cengage Learning.
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  • Norris, K., et al. (2020). Managing crisis in the entertainment sector during post-pandemic recovery. International Journal of Business & Management, 15(4), 112-129.

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