The Concept of Elasticity in Business - Research Paper Example

The Concept of Elasticity in Business Abstract Elasticity is one of the most significant concepts of business. Entrepreneurs are able to develop a strong pricing strategy through the use of elasticity. This paper critically evaluates the concept of elasticity in business. It focuses on the price elasticity, illustrating how changes in prices may affect the demand and supply of a commodity. It also highlights other factors that may affect elasticity apart from price, such as changes in consumer income as well as the presence of substitutes. The paper concludes with a suggestion of two areas in which further studies regarding elasticity would be significant. Introduction Elasticity is one of the micro-economic concepts that are significant for investors while analyzing the operating environment. It helps them to determine the response of consumers on a shift in the prices of a commodity. The most significant role elasticity plays in a business is helping the investor to set the prices of commodities. An effective pricing strategy is significant in maintaining competitiveness in the market as well as maintaining a large consumer base. It requires knowledge regarding consumers as well as competitors. Data on price elasticity of demand can be used to make predictions regarding future sales (Vaishampayan 2007 p 36). Elasticity quantifies the receptiveness of demand for commodities to price changes. Elasticity can be used to improve sales or the quantity demanded, depending on the anticipated reactions by consumers to price changes. For example, a producer may decide to increase the sales/quantity demanded through reducing the price of commodities. If consumers are sensitive to price, they are likely to purchase more. In that case, demand is elastic. On the other hand, when consumers are not sensitive to prices they are unlikely to purchase more. The demand therefore is inelastic (Cachon & Terwiesch, 2008 p 91). There are other forms of elasticity, such as price elasticity of supply, whereby when the supply is high, producers tend to increase the quantity supplied in the market. Income elasticity on demand is also a significant form of elasticity that affects a business. When for example the consumer’s income rises, they tend to demand more and vise versa (Fairey 2006 p 73). This essay is a critique of elasticity. It mainly focuses on the price elasticity on demand and supply, and some aspects of income elasticity on demand. The essay also highlights the significance of elasticity in planning for improved performance in the business. It also highlights two areas of further research in regard to elasticity. Price Elasticity of Demand A percentage change in price that results to a percentage change in the quantity demanded leads to price elasticity of demand (Cachon & Terwiesch, 2008 p 93). This statement can be represented as; Elasticity = Percentage Change in Quantity Demanded Percentage Change in Price This can be represented in a curve (see fig. 1) Fig. 1. Price Elasticity of Demand The steepness of the curve is the determinant of the level of elasticity. When the curve is gently sloping as in the illustration above, it means that a small change in price corresponds to a large change in the quantity demanded, meaning that the demand is elastic. A steep curve means that a high change in price corresponds to a lower change in the quantity demanded, hence the elasticity is minimal. This concept can be used by producers to determine the pricing strategy. If the demand is elastic, producers can increase sales through a reduction in the prices of commodities. On the other hand, if demand is inelastic, it means that there are other factors that consumers consider in determining the quantity to be purchased. In such a case, sales can be increased through raising the prices of commodities until signs of elasticity in demand appear. It means that sellers should target the maximum point whereby any more increase in price will affect demand (Vaishampayan 2007 p 56). Ohidul (2005 p 259) observes that price elasticity of demand occurs differently in different products. The demand for necessities is likely to be inelastic. This is because consumers can not do without them. For example, changes in the prices of essential food commodities are unlikely to affect demand since consumers have to use them for their continued existence. On the other hand, demand for commodities that are not regarded as essential for life may be highly elastic since consumers tend to purchase when the price is affordable, and less when the prices are high. However, there are certain goods that people purchase, as a result of associating their price with quality. They tend to believe that the higher the price, the higher the quality. Fairey (2003 p 66) observes that the demand for goods of ostentation is different from the demand for necessities in the sense that an increase in price leads to an increase in demand. It is assumed that high price is associated with good quality. Effect of Substitutes on Elasticity Even though price is a major determinant of the shifts in demand, leading to elasticity, there are other factors that determine the elasticity of demand. One such factors includes the availability of other goods that consumers can use in the place of a commodity for which prices are high (Ohidul 2005 p 259). For example, an increase in the price of cooking gas may compel consumers to turn to other sources of cooking fuel. This means that elasticity will be affected since the demand for the commodity will reduce. Even without a change in the price of a commodity, the emergence of a new commodity may lower the demand of another. For example, the development of flash disks and CDs that are more superior information storage devices led to a reduction in the demand for the 31/2 inch floppy disks that have a lower volume and durability. Few people currently use the originally popular storage devices. However, if the price of the flash disks and CDs increase, the 31/2 inch floppy disks would be preferable substitute for the consumers who may not afford the new devices. This is an important aspect that is significant for the suppliers in price determination. Effect of Consumer Income on Elasticity It is also important to understand that consumers purchase only what they can afford. This means that a reduction in their income may lower the demand of a commodity, even when the prices are constant. The demand becomes more elastic. On the other hand, they will be willing to spend more if there is an additional income, which may raise the demand for a particular commodity (Vaishampayan 2007 p 71). In other words, elasticity of demand must not always be dependent on price. There are many other factors that affect the demand for commodities. For example, the demand for coffee may be high during the cold season while it may be low during the hot season irrespective of the prices. Elasticity of Supply Elasticity may also be evident in the supply of commodities especially when producers are motivated to offer more of their products in the market as a result of price increases. It usually occurs when there are external forces that raise the demand of commodities, hence a rise in price (Ohidul 2005 p 259). For example, recent studies indicate that Aloevera, which is a wild herb, is an important source of medication, especially when applied raw. The suppliers who were offering the herb at a lower price for production of little known pharmaceuticals are now reaping high profits from as a result of the new discovery. The herb that has been traded in unnoticeably for many decades attracted a lot of suppliers as a result of a rise in the price. Before, people could not spend time in the wilderness looking for the low priced plant. After the realization that it can fetch high profits, farmers began growing it on their farms, leading to increased supply. The situation of Aloevera can be represented in the supply curve (see fig. 2) Fig. 2. Price Elasticity of Supply If the curve is gently sloping, it indicates that a little change in price leads to a large change in the quantity of Aloevera supplied. This means that the supply is highly elastic. On the other hand, a steep curve indicates that a large change in price leads to a small change in the amount of the commodity supplied, meaning that the supply is inelastic. Conclusion Elasticity is one of the important aspects of business that is significant in determining the price of commodities. An elastic demand occurs when a little change in the price of a commodity results in a large difference in demand. Such kind of demand is usually found in commodities that consumers can do without, since a rise in price leads to a reduction in demand. Inelastic demand occurs when a change in price does not affect the quantity demanded. This is characteristic of necessities, which consumers must use regardless of the price Fairey (2003 p 71). Other factors that influence elasticity include the availability of substitute commodities that lower the demand even if the price remains constant as well as income of the consumer. It is important to conduct further research regarding the impact of elasticity on business performance through case studies of various businesses. This would assist in determining how different businesses respond to elasticity and whether they reap benefits or they incur losses. It is also important to conduct further research regarding the availability of substitute commodities. This would help in understanding how elasticity would be if the prices of substitutes fluctuate, making consumers to lose confidence in opting to purchase them. References 1. Cachon, G. & Terwiesch C. Matching Supply with Demand: An Introduction to Operations Management, McGraw Hill, 2008 2. Fairey, S. Obey: Supply & Demand : The Art of Shepard Fairey, Gingko Press, 2006 3. Ohidul, H. M. Income Elasticity and Economic Development: Methods and Applications Series. Advanced Studies in Theoretical and Applied Econometrics, 42.17 (2005): 259 4. Vaishampayan, J. V. Managerial Economics: Theory Numericals and Cases, New Royal Book Company, 2007 Read More