Impact of Elasticity of Demand on Pricing
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Added on 2021-02-19
Impact of Elasticity of Demand on Pricing
Added on 2021-02-19
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Economics - GDP Inflation
TABLE OF CONTENTQUESTION 1...................................................................................................................................1Impact of elasticity of demand on pricing ..................................................................................1QUESTION 2...................................................................................................................................2Economies of scale and long run average cost curve .................................................................2QUESTION 3...................................................................................................................................3Elements bringing growth in GDP per capita .............................................................................3QUESTION 4...................................................................................................................................4Impact of changes on substitution bias and new goods bias .......................................................4REFERENCES ...............................................................................................................................5
QUESTION 1Impact of elasticity of demand on pricing Price elasticity is defined as the measurement of responsiveness of target customerstowards the changes made in price of products or services. Thus the parameter is important interms of evaluating the changes in profitability or revenues when operational factors such asprice are changed. Price elasticity describes the relationship between the demand and price ofproducts so that company can effectively modify its pricing pattern and strategy (den Hoed,2016). It can be calculated by dividing the percentage change in demanded quantity of productwith percentage change in price. At present the elasticity of demand (EOD) for the new drug of pharmaceutical companyis 1.4 which is greater than 1. It shows that demand is elastic and it respond in greater proportionto price changes. As a result if company will enhance its price then it will result in significant fallin the revenue. Thus it is recommended that with 1.4 EOD company must lower its prices so thatnumber of sales can be increased and overall revenues will also be increased. Elastic nature ofEOD indicates that either customers have other alternative product choices or they are highlysensitive towards the changes in price. (Source: Price elasticity of demand, 2019)(MR is marginal revenue, TR is total revenue and AR is average revenue)1Illustration 1: Effect of PED on revenue
On the other hand if company has EOD between 0 and 1 then demand is known to beinelastic and responsiveness of customers demand is in lower proportion as compare to changesin price. Thus when company will have EOD as 0.6 then company is suggested to enhance itsprices. Due to increments in price though number of sales will reduce but overall revenuegeneration will be increased (Goodwin and et.al., 2015). If the drug is highly effective andcustomers does not find any other alternative for the product then such products can achieveinelastic demand and then even at higher prices there will be increment in revenue withoutaffecting customers purchasing decision. EOD equals to unity shows that demand is unit elastic and thus there is equal proportionof demand changes as variations in the price. Thus when EOD is 1, the company will bereceiving maximum revenue and there will be no impact of increasing or decreasing prices. Insuch case company must keep its prices constant so that number so sales can be retained. QUESTION 2Economies of scale and long run average cost curve The auto mobile industry integrates the technology, physical capital and labour for theproduction processes. For the long term sustainability and profitability all firms are required toselect the most feasible technology so that variable costs can be achieved. Thus in order to gainleast possible average cost for long term companies will aim at replacing expensive inputs withrelatively inexpensive options. Among certain manufacturing industries such as auto-mobilesthere are situations in which average production cost for each unit reduces significantly as thelevel of output or sales is increased (Bade and Parkin, 2015). This situation refers to theeconomies of scale and is also one of the characteristics of auto-mobile industry. The long run average cost (LRAC) curve indicates the minimum or the least possibleproduction cost (average) when all input variables of production can be varied in accordance tothe production technology chosen by company. For the auto-mobile manufacturing firms LRACcurve has downward slope which indicate economies of scale. A flat curve represents constantreturn on sale while upward slope is indicator of diseconomies of scale (Moosavian and Ali,2016). Within diseconomies there is direct proportionality in average cost and number of outputlevels while in constant returns average cost of the units is independent of changes in outputs.The conjunction of LRAC with market demand helps in determining the number of firms whichcan exist in the given market segment in terms of competitiveness and market demand. 2
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