Role of Price Elasticity in Economic Analysis and Business Application of Different Elasticity - Essay Example

Table of Contents Introduction 2 Important terms 2 Elasticity of demand 2 Importance of elasticity to business 3 Type of elasticity 4 Income elasticity 6 Cross Price elasticity 7 Conclusion 8 References 9 Introduction Economic analysis holds importance for business units and businesses takes decision to ensure that the efficiency improves. Price elasticity is a concept which holds importance while a business frames a business decision. The different elasticity determines the decision making of a business. The paper looks into the manner elasticity holds importance for business units and the importance being laid on different elasticity. The paper also looks into the different elasticity’s and the importance being laid on those. Important Terms Elasticity holds importance in business decision making as it decides the course of action a business will take. Before moving on it is important to discuss some specific terms which will help to improve the learning process. Demand is “the amount of goods demanded at a certain price” (Colell, Winston, Michael, & Jerry, 1995) where as supply is “the amount of goods the producers is willing to supply at a given price”. (Colell, Winston, Michael, & Jerry, 1995) Elasticity refers to “the change in demand due to change in price”. (Colell, Winston, Michael, & Jerry, 1995) Elasticity of demand Elasticity of demand has a special position in the eye of the stakeholders as it helps to determine the price and the total revenue the business looks to earn in the near future. (Rizzo and Blumenthal, 1994) Business can forecast on the basis of price elasticity by determining the amount of goods they are going to produce at a certain price. The following graph shows that a change in price affects the quantity supplied and the quantity demanded. It is seen that as demand increases from D1 to D2 it increases the price making people supply more which reduces the price again and determines the equilibrium price. Importance of elasticity to business The business units can determine the amounts of goods they wish to produce and forecast accordingly. Elasticity will thereby help in understanding the quantity that will ensure there is no excess stock and the funds are utilized efficiently thereby generating more revenues. A study in this direction shows that elasticity helps the tourism industry forecast the number of visitors and prepare accordingly. Based on the elasticity the tourism sector can identify the areas that needs to be worked upon and the price they need to charge to the customer so that the marginal return maximizes. (Crouch, 1994) Price elasticity helps business units to determine the price the price competitors charge and the strategy they are looking to use in the market. (Rizzo and Blumenthal, 1994) This helps the business unit to decide upon their strategy and ensure that the competitors’ strategies are integrated with their own strategy which will help to increase the customer base and ensure returns for the business. Elasticity helps the business to identify the areas that affects the demand and requires special effects to reduce it. Depending on the usage business units determine elasticity to be different in different situation. It is seen that business units need to continuously evaluate the elasticity’s to be able to determine the effect it is having on the normal functioning of the business. A study in this direction shows that the price elasticity of demand has different effects on different groups of customers consuming alcohol. This study found that youths get affected due to price elasticity as the increases in the price reduces their consumption but when in adults price relatively plays little importance in the consumption of alcohol thereby putting business units in a dilemma to determine the effectiveness of the elasticity of demand. (Chaloupka, Grossman & Saffer, 2007) Type of elasticity This highlights that elasticity’s are of different types as shown below Here, we see that the different elasticity makes business take different decision. In the above graph we see that in figure a elasticity is perfectly inelastic and the demand will remain the same irrespective of the price. In figure b we see that the price remains the same irrespective of the demand. In figure c we see that the change in price equates the change in demand. These are the three situations which is rare in the business world. Business thereby concentrates on figure d and e which states that a small change in price has a huge effect in demand as in figure d and figure e states that a small change in demand has a huge effect on price. Business units thereby concentrate and look towards finding the point at which their elasticity lies. It is important that businesses identify it correctly as it can have a long them bearing on the performance and decide the direction the business unit needs to take to ensure that they are able to forecast correctly. Income Elasticity There are other elasticity’s which helps business units to formulate their future decision based on those. One such is the income elasticity. This elasticity determines the change in demand due to change in the income or the real purchasing power of the customer. (Rizzo and Blumenthal, 1994) This has a huge role to play as it determines the amount of goods the business will be able to sell in the market. Business units look forward to integrate this elasticity in their formulation of future plans so that they are able to better understand the market. The graph for the income elasticity appears as follows Here as the income or the purchasing power rises the demand for goods rises. This provides an opportunity for the business units to integrate it in their scheme of things and manufacture goods accordingly. This thereby plays a role in shaping the performance and determining the manner the future action will be taken. Cross Price elasticity Another important price elasticity considered by business is the cross price elasticity of demand. It states that as the price of a particular product raises people shifts their consumption to other similar products in the market. (Colell, Winston, Michael, & Jerry, 1995) This makes it important that business units identify the cross price elasticity as it will help to understand the substitute products available in the market. This will help the business units to develop a model which suits their requirements and based on those the business can work towards improving the business by ensuring a price which attracts maximum customers. Business units look forward to find all the type of elasticity and based on those take decision which will help them ensure that all the things are integrated. This will help the business units decide on the supply and plays a huge role in deciding the cost actor. Businesses based on it can determine the wages and other expenses the business units want to incur. Business units can thereby plan and forecast the future based on it. The predictions based on it are better as it integrates a lot of things and considers the prevalent economic condition. Since, it integrates the competitors’ strategies and the goods they are producing at a certain price will help business units to ensure that the decision based on those is better. Conclusion The paper thereby identifies the importance of different elasticity and the benefits the business can accrue due to it. It is seen that business are laying importance to elasticity and calculating it at regular intervals to identify their future strategy and the manner in which it will be influence their decision. Thus, the paper highlights the importance of elasticity for business units. It also highlights the different areas of elasticity which helps in determining the prices and the competitors’ strategy. This thereby increases the importance of elasticity and with the different tools of elasticity the value multiplies for business units as they can ensure that the decision based on this are better and will help the business unit grow and ensure that all the steps are taken in the right direction. References Crouch G, 1994, “Price elasticity’s in international tourism”, Journal of Hospitality and Tourism research, Volume 17, Issue 3, page 27-39 Chaloupka F, Grossman M & Saffer H, 2007, “The effect of alcohol prices on consumption and alcohol related problems”, Journal of Health economics, Volume 66, Issue 2, pg 214-249 Colell M, Winston A, Michael D, & Jerry R, 1995, “Microeconomic Theory”, New York, Oxford University Press Rizzo J and Blumenthal D, 1994, “Physician Labor Supply: Do Income Effects Matter”, Journal of Health Economics, Volume 13, Issue 4, pg 433–453 Read More