Question

A paragraph for each one- with references

First Scenario: For most business firms that sells a particular good on the market, a decision has to be made from time-to-time to either raise the price of the good, lower the price of the good, or keep the price of the good unchanged.

Based only on the concept of demand elasticity:

1. When would you recommend raising the price of the good? Explain why.
   
2. When would you recommend lowering the price of the good? Explain why.
   
3. When would you recommend keeping the price of the good unchanged? Explain why.
   

Second Scenario: Having become a “master of elasticity” due in large part to taking a course in microeconomics from world famous Indiana Tech University, you are hired as a consultant to a firm that is currently considering raising the price of its product in the hopes of earning a higher profit. Reviewing the firm’s books and the overall market for the product, you have calculated that the price elasticity of demand for the firm’s product is -1.05.

Based on your calculation:

   A. What advice will you give regarding the proposed price increase, and how will
       you explain your advice so the firm’s leadership understands the rationale of
       your advice?

Answer 1

First Scenario

Case 1: we know that there is an inverse relationship between price and quantity demand. However, the proportionate change between theme will be different based on the product. So, a firm shall consider the elasticity of the product to fix a price.

If the product is relatively inelastic or perfectly inelastic the increase in price will not negatively affect the demand but will increase the profit. In the case of perfectly inelastic product, quantity demanded will not be affected by the price change (i.e.firm can sell the same quantity at a high price).  In the case of relatively inelastic product, the proportionate decrease in quantity demanded will be less than proportionate increase in price. This will increase the overall profit of the firm.

Case 2; If the product is relatively elastic or perfectly elastic the decrease in price will not negatively affect the demand but will increase the profit. In the case of perfectly elastic product, a small decrease in price will lead to an infinite increase in quantity demanded.  In the case of relatively elastic product, the proportionate increase in quantity demanded will be more than proportionate decrease in price. This will increase the overall profit of the firm.

Case 3: If the product is unitary elastic (i.e. the proportionate change in quantity demanded is exactly equal to the price). In that case, if the price is increased by 10% then quantity demanded will decrease by 10%. In other words, whatever profit you earn from an increase in price will be nullified by a decrease in demand (i.e. no profit or loss). Hence, in this case, the price shall be unchanged.

Second Scenario

Since the elasticity is more than one (1.05) we shall know that the product is elastic in nature. the elasticity of the product says that in price is increased by 10% than you will lose demand by more than 10% (Suppose 15%). This will ultimately bring loss not profit because due to increase in price there is a fall in quantity demanded by more than the increase in price. so it will not create high profit but loss. Hence, it is not beneficial to increase the price.

Note: The -ve sign of price elasticity represents the inverse relationship between the price and quantity demanded.