Question

Please diagram the revenue and profit situation (which would also include the cost curves) for a producer of a highly elastic (but not perfectly elastic) good of your choice (a restaurant, boutique clothing store, etc.). Under what circumstances would it make sense for them to raise their price?

While profit maximization is the main goal for most firms (and one which you should be able to represent on a diagram), you may wish to consider alternative goals depending upon the business you have chosen.

Answer 1

A good is considered to be highly elastic if the quantity demand of the good changes drastically when the price of the good increases or decreases. Elasticity measures change in behaviour of one variable(Quantity) due to change in other variable(price). Let us take restaurant as example to understand better how quantity demand will change due to change in price.

If % change in quantity > % change in price, then (% change in quantity/ % change in price) > 1, and the good is called elastic.

The more is the % change in quantity due to % change in price, the more is the elastic is the good.

It is mentioned in the question that the producer belongs to a highly elastic good category, means, even a small change in price of the good, increase or decrease will have major impact on the quantity(demand) of the good.

Let us take for an example, if the producer runs a restaurant and if during some days, he reduces the price of the product, the demand for the items available in the restaurant will increase majorly that day.

Similarly, if he increase the price, say for few days, the quantity (demand) impact will be major in those days as well, means the demand will fall drastically in this case.

This is how the quantity change happens when the demand for a good is highly elastic in response to price.

Example : The restaurant owner reduces the price of the products on a special festive day by 25%. Elasticity determines whether or not this promotional offer will be viable. As it is given that the good is highly elastic in nature, means the impact of change in prive of the good will be drastic in this case. This is how elasticity study is helpful for businesses. Consider image 3 below for diagramatic presentation of this example. In that figure, it is shown that even the small change in price of the good is leading to big change in quantity(demand) of the good.

Similarly, price increase impact on quantity can be drawn.

Maximization Diagram for Revenue and Profit Situation for a producer of a highly elastic good 10 351 EX (Elastic) 3.5 zot 2.5. (Unit Elastic) E=1 uch tot ELT (Less Elastic) 0.5t N+ 3 4 5 6 7 8 Qty. (Profit Revenue Expendituee Cweve 2 3 4 5 6 7 8

DATE PAGE Price 2 O o 2 a Questy Effect showing change in Price ; 3. Lost Revenue P. from selling at a lowes price Demand Increased a 1 Revenue from a selling more at 1: a lower price of . Q2 Ity As the of age change in quantity, due to % age change price greater than 1, demand is highly elastic. 4. Elastic Demand Cwere & us Si S2 Price Demand Quantity

Please see the images uploaded above for the diagramatic presentation.

The first image tells us the elasticity and as the product is highly elastic, it means producer is producing at that level of the curve where elasticty is greater than 1 (E>1)

As we are producing at level where elasticity is greater than 1, even a small change in price will have a great impact on quantity(demand). - As depicted in image 3 above.

The revenue is maximum at the point where the elasicity of the product is equal to 1, because this is the point where change in price will not impact the demand (quantity sold by the producer).

At any point, other than that, either price effect will outweigh the quantity effect or vice-versa causing less revenue.

The price of the product can be increased if the cost of the product increases for producer as in general industry product cost or if the producer is working in a monopoly marketplace. Otherwise, increase in price of the product will have major negative impact on demand due to highly elastic nature of the product.