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Unformatted text preview: m $2.20 to $1.80 a pack. The
announcement sent shock waves through the cigarette industry. The reaction in the stock market was swift
and punishing: Phillip Morris’s stock price dropped 23 percent in a single day, erasing $13.4 billion in
stockholder value. That day was immediately dubbed “Marlboro Friday.” How much would Marlboro sales
have had to increase in response to a price reduction to $1.70 for that price reduction to increase profit?
Assume packs of Marlboros each cost $1.00 to produce.
Instructions: Round your answer to nearest whole number.
Sales need to increase by more than 71.43 ± 1 percent. rev is ed jrl 08112011 Explanation:
Would a price reduction really be such a bad idea for Phillip Morris? That depends crucially on two things: (a)
how much Marlboro sales would increase after the price reduction and (b) how much it would cost Phillip
Morris to produce the extra cigarettes. Denote Marlboro’s sales before the price reduction QB and sales
afterward QA. Then, the price reduction would raise profits if: (1.70)QA – C(QA) > (2.20)QB – C(QB).
Another way to put this is that overall profits would increase if the profit earned on the extra sales exceeded
the revenue lost on existing sales: (1.70)(QA – QB) – [C(QA) – C(QB)] > (0.50)QB.
If the extra packs Phillip Morris sold as a result of the price reduction each cost $1.00 to produce, so that C(QA)
– C(QB) = QA – QB, then the price reduction would be a good idea if: (1.70)(QA – QB) – (QA – QB) > (0.50)QB (0.70)(QA – QB) > (0.50)QB.
Dividing by QB and rearranging terms, this expression tells us that the price reduction would raise profits if: (QA – QB)/QB > 0.50/0.70 = 0.71.
That is, if we are using the correct cost for the extra packs, then this price reduct...
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- Fall '13