Report on Price Elasticity and Recommendations for Maximising Profit

This report discusses the concept of price elasticity and provides recommendations for maximising profit through changes in product price. It includes graphs and calculations to illustrate the impact of price changes on revenue and discusses factors that influence price elasticity. The report also covers cross price elasticity and its implications.

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Purpose
The key purpose of this report is to provide recommendation with regards to decision related
to changes in price of the product with the objective of maximising profit. These decisions
are pivotal for a business considering that the changes in the price of a given product tend to
impact the sales quantity of the underlying product. As a result, the revenue would be
contingent on the pricing of the product. Also, the quantity demanded for a given product
may be impacted by the corresponding price changes in products that are complementary or
substitutes.
Method
In order to achieve the above purpose and highlight prudent recommendations, the concept of
price elasticity has been used. This concept highlights the rate of percentage change in
quantity demanded by a unit percentage change in the underlying variable. The price
elasticity of demand highlights the percentage change in the quantity demanded when there is
a unit percentage change in the price (Arnold, 2017). The underlying impact on the revenue
would be contingent on the nature of demand which may be elastic and inelastic. Also, the
various factors that influence the price elasticity of demand have also been discussed to
enhance overall understanding. Additionally, cross price elasticity concept has been used to
highlight the nature of relationship between products.
Results
Question 1
In order to enhance total revenue, price ought to be decreased. This can be illustrated through
the use of following graph.
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Question 2
In order to enhance total revenue, price ought to be increased. This can be illustrated through
the use of following graph.
Question 3
The total revenue would not alter irrespective of the change in prices and hence the revenues
are already maximised at current prices. This can be illustrated through the use of following
graph.
Question 4
The various factors that influence the price elasticity of demand value are indicated as
follows (Mankiw, 2014)
 The availability of close substitutes
 Nature of good i.e. basic or luxury
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 Contribution of product expenditure on the budget of customers
Question 5
Price elasticity may be mathematically represented as follows (Krugman, 2017).
Price elasticity = (Percentage change in quantity demanded/Percentage change in price)
Based on the given data, the price has risen from $ 80 per unit to $ 100 per unit.
Percentage change in price = [(100-80)/80]*100 = 25%
Also, owing to increased price, there has been a drop in the sales from 100 units to 40 units.
Percentage change in quantity demanded = [(40-100)/100]*100 = -60%
Price elasticity of demand = -60/25 = -2.4
Question 6
The customer would be called as price conscious owing to the elastic demand.
Question 7
The formula of cross elasticity in the context of the given data is given below (Nicholson and
Snyder, 2015).
Cross elasticity = Percentage change in quantity demanded for X/Percentage change in price
of Y
Based on the given data, it is apparent that the price of Y has increased from $5 to $7.
Percentage change in price of Y = [(7-5)/5]*100 = 40%
The cross elasticity is given as 3.2
Hence, 3.2 = Percentage change in quantity demanded for X/40%
Thus, Percentage change in quantity demanded for X = 128%
Let the pieces of X that are sold when price of Y is $7 be X7
128 = [(X7-100)/100]*100
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Solving the above, we get X7 = 228 pieces
Question 8
a) Positive cross elasticity would be exhibited in case of substitutes.
b) Negative cross elasticity would be exhibited in case of complementary goods.
c) Cross elasticity is zero when the goods are unrelated.
Discussion
Question 1
From the graph attached, it is apparent that in case of elastic demand, for a unit change in
price, the corresponding change in quantity demanded is significantly higher. As a result, it
makes sense to reduce price. By reducing price, the percentage increase in quantity demanded
would be significantly higher than the price reduction, thereby leading to increased total
revenue (Pindyck and Rubinfeld, 2016).
Question 2
From the graph attached, it is apparent that in case of inelastic demand, for a unit change in
price, the corresponding change in quantity demanded is significantly lower. As a result, it
makes sense to increase price. By increasing price, the percentage decrease in quantity
demanded would be significantly lower than the price increase, thereby leading to increased
total revenue (Arnold, 2017).
Question 3
The percentage change in price and quantity demanded would be equal which would tend to
cancel each other out. As a result, there is no change in total revenue on account of changes
in price (Krugman, 2017).
Question 4
One of the key determinants of price elasticity of demand is the nature of goods. Typically
for items that are staple goods, the demand is inelastic as irrespective of changes in prices,
these are consumed by the households. However, in case of luxury goods, the consumers can
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defer their purchase if the prices increase and hence the demand is highly elastic (Pindyck
and Rubinfeld, 2016).
Another crucial factor is the availability of cheaper substitutes. For those goods where close
substitutes are not available, the demand tends to be inelastic as when price rises, the
consumers have little choice in terms of availing cheaper alternatives. However, in case of
goods where abundant substitutes are available, demand would be elastic as consumers would
readily shift to alternatives when there is increase in price (Mankiw, 2014).
Yet another variable of significance is the contribution of purchase of good to the overall
budget of the consumer. Typically demand is more elastic for these goods on which a higher
proportion of budget is allocated since any increase in price of these would have significant
impact on the consumer’s budget (Besanko and Braeutigam, 2015).
Question 5
The price elasticity of demand has been computed as -2.4 which implies that the underlying
good adheres to the law of demand and also has a elastic demand (Arnold, 2017).
Question 6
The price elasticity of demand is higher than 1 which implies that the percentage decrease in
quantity demanded would be higher than the corresponding percentage increase in price. This
clears highlights that the consumer is highly price sensitive with disproportionate changes in
quantity demanded as price changes (Mankiw, 2014).
Question 8
a) A positive cross elasticity would indicate that when there would be a increase in the price
of product Y, then there would be a positive impact on the quantity demanded of another
product X. Considering that higher price of Y should lead to lower demand of Y, hence
increasing demand for X indicates that it is substitute (Besanko and Braeutigam, 2015).
b) A negative cross elasticity would indicate that when there would be a increase in the price
of product Y, then there would be a negative impact on the quantity demanded of another
product X. Considering that higher price of Y should lead to lower demand of Y, hence
decreasing demand for X indicates that it is complementary good (Arnold, 2017).
c) A zero cross-elasticity would imply that for any change in price of Y, the quantity
demanded of X would not alter which implies unrelated goods (Krugman, 2017).
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Recommendations
Based on the results and the followed discussion, the company should decrease prices when
price elasticity is 2.5 for increasing the total revenue. However, when the price elasticity is
0.8, then the demand is inelastic and hence price should be increased to increase the total
revenue. In case the price elasticity of demand is 1, then no changes in price would be
recommended as the total revenue is already maximised. There are three main factors that
would influence price elasticity i.e. availability of close substitutes, contribution of spending
on good to overall budget and nature of good.
The price elasticity of the product has come out as -2.4 which is indicative of highly elastic
demand indicating that the consumers are price sensitive. Considering the cross elasticity
between X and Y, it can be recommended that if the price of product Y is increased from $5
per unit to $7 per unit then the quantity demanded of product X would increase from 100
pieces to 228 pieces. With regards to the cross elasticity, a positive value highlights that the
underlying products are substitutes. A negative value represents complementary products
while a zero cross elasticity indicates unrelated goods.
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References
Arnold, A.R. (2017) Microeconomics. 9th edn. Sydney: Cengage Learning, pp. 75-76
Besanko, D. and Braeutigam, R. (2015) Microeconomics. 4th edn. New York: John Wiley &
Sons, pp. 113-114
Mankiw, G. (2014) Microeconomics. 6th edn. London: Worth Publishers, pp. 123-125
Nicholson, W. and Snyder, C. (2015) Fundamentals of Microeconomics.11th edn. New York:
Cengage Learning, pp. 45-46
Krugman, P. (2017) Microeconomics. 2nd edn. London: Worth Publishers, pp. 67-69
Pindyck, R. and Rubinfeld, D. (2016) Microeconomics.5th edn. London: Prentice-Hall
Publications, pp. 98-99
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