Question

Why would a firm care about the elasticity of the good it sells? Think about how elasticity affects the firm's behavior when it wants to increase total revenue.

Answer 1

1. To businesses, price elasticity is critical because it will affect the price they pay to different products or services. If an item has an elastic demand, this means that as the product price increases, the amount demanded will change. As the price changes, companies will need to monitor closely how demand for their goods changes. For example, if the milk price doubles, the demand for milk is likely to drop as it is an elastic demand commodity. If a product has an inelastic demand, businesses need not be as sensitive to price changes mainly because people need that product or service regardless of price. The price of visiting a doctor would be a good example of this. If a person was really ill and in desperate need of medical care, he or she is likely to pay whatever cost the doctor has been paid. A person for the best rate likely wouldn't shop around. There's a similar situation with coal. When oil prices rise, people are still going to buy gasoline because they have to get from place to place.

Price elasticity of demand is a measure of a commodity's demand for increase in quantity due to a price change. When demand is inelastic, a price increase leads to higher sales. The market becomes flexible if the price rise results in lower sales.
Understanding the cost elasticity of demand, a business must agree on its commodity's optimal price level to achieve its sales goals. Price elasticity information can help them decide how much price reduction is needed to increase revenue to a certain target, or what level of price increase is optimal (because decreased demand can wipe out extra revenue from a price increase).

2. A shift in value leaves the amount ordered or supplied untouched by a perfectly inelastic demand or supply. The quantity ordered or supplied in this case does not respond to price changes. This form of demand occurs when buyers have no alternative products to satisfy their needs; if producers have no substitute goods to produce, a perfectly inelastic supply exists.

A manufacturing company works at full capacity and is therefore unable to increase supply. The management decides to hire some additional workers to help with the high level of production, but as the company operates at full capacity, its short-term capital has also been exhausted. The company also runs out of products or raw materials and the lack of short-term resources makes it impossible to increase the supply

Another issue currently facing the organization is the labor constraints. While production does not require highly skilled labor, it is important for management to hire additional employees. These workers will work with the minimum wage for five hours a day. Nevertheless, because of the limited production factors and the lack of short-term resources, the company is currently unable to increase supply. Even if it recruits new workers, it will take some time for the company to reach a higher production level. A larger plant, more staff, and more long-term capital are likely to be needed.