Price Elasticity and Decision Making

Introduction

In the business world the levels of the demand of goods and services as well as the supply keep on responding to changes in prices. The degree to which they react is known as the elasticity of the curve. It’s a fact that some goods and services are of more importance to the customers than others and that’s why elasticity is different among products (Maurice, & Thomas, 2008). Goods and services which are basic to consumers are affected less by the price changes as they will still consume despite the increment of the price, these are the goods called inelastic and they are marked by price elasticity of less than one. However the price changes of goods which are considered less importance are affected greatly, these goods are called elastic and they are marked by price elasticity of more than one.

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Factors affecting price elasticity

There are five major factors which affect the price elasticity of demand for any good or service. The first category is under the goods recognized as luxurious or those which serve as necessities for life. For necessities price changes will not have a great effect on the demand but for luxurious goods it’s opposite. The second category is of goods with close substitutes, a small change in price for these will result to a great change in demand (Maurice, & Thomas, 2008). Goods with no close substitutes are not affected greatly with price changes. Thirdly are the goods and services which consume a small percentage of someone’s income. These goods have inelastic demand unlike the expensive ones which tend to be elastic. Price elasticity is also determined by the durability of a product. Non durable goods have inelastic demand while durable ones have elastic demand. For instance smokers continue with their habits even if the prices change.

Pricing policy of the firms

The price elasticity of demand has effects on the performance of the business. The main purpose of the business is to reduce the expenses and maximize the profits. One way of achieving this it to utilize the price elasticity of demand as it can help in setting the best pricing policy ( Brent, 2008).The price elasticity of demand determines the price to be set for goods and services such that it affects the final revenue gotten and the management of the production. For instance, it’s much applicable in a monopoly firm when it’s setting its prices for goods and services.

When the sales are at the top the demand for goods is inelastic and when the sales are low the demand is elastic. This will help the decision makers in the firm to set the right prices depending on the elasticity of demand. When the sales are high the firm will set higher prices and low prices when the sales are low (Hirschey, 2009).By use of price discrimination the monopoly firm will maximize its production as well as the profit. Some factors which affect the price elasticity of demand can assist the firm to make decisions on setting the prices on bases of ideas gotten from price elasticity.

Secondly, a company may realize that the switching cost has an adverse effect on the demand price elasticity. Therefore, the company may decide to raise the switching cost hence leading to inelastic of demand charging slightly high prices (McConnell, Brue, & Campbell, 2004). When the switching cost is raised customers cannot afford to move to other companies easily. Moreover, companies in competitive markets should put into consideration the price as it’s a major strategy for competition. This applies much when the competitors are dealing with same types of products and products which can be used as substitutes. This leads to a more elastic price which affects the volume of sales. In addition, for a monopolistic market introduction of more competition and regulation of prices is much essential (Sloman, 2006). The demand becomes elastic and a more competitive market. Moreover, businesses make use of market statistics to determine what consumers prefer, especially the demand price elasticity for their products. This enhances complete satisfaction of the consumers and increment of sales in return.

Tax imposition by the government

The government puts into consideration the price elasticity of demand before putting the indirect taxes. When taxes are put, the prices of these goods go high putting some effects on their supply. If these goods happen to be elastic, as a result the consumers will reduce their level of purchasing as the price increases. As a result, less tax is paid due to inelasticity of price elasticity of demand (Vaidya, 2005). In cases of elastic goods, the government avoids imposing taxes as they collects very little amount of revenue and in return they impose heavy taxes on inelastic goods where it obtains much revenue. For instance there are several cases where the government has been imposing taxes on alcohol which is which the demand is inelastic. The demand of alcohol depend more on habits than on the prices that’s why even if the government imposes heavy taxes it still harvests a lot of revenue from it.

Setting of the prices by the government

On the other hand the government uses the price elasticity to determine the prices of the goods and services which are under its control. If a certain product has price elasticity more than one, unless it has a very great impact the government can not take any step forward to change the price. An example is luxurious goods a small increment of the price will lead to many people foregoing to purchase. If the good has a price elasticity of less than 1 the government can decide to increase the price as it desire (Sloman, 2006). This happens because the commodity is a necessity and people must purchase even if they will do it in small quantities. These are goods like food.

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The most important idea of price elasticity to the government is to help it know the goods and the services which have elastic or inelastic demands. This helps the government do the pricing accordingly to get as much revenue as possible through taxes. Price elasticity helps the government to set up the price ceilings and price floors to protect both consumer and the producer. This protects the producers from being kicked out of the market and the consumer from being exploited through high prices. In addition, price elasticity enables the government to be aware of the possible impacts on changes of indirect taxes (Vaidya, 2005). Sales taxes, levies and duties are the indirect taxes charged on commodities like fuel, cigarettes and alcohol.

This is critical because if a government decides to put an exercise duty on a commodity whose demand is relative price elastic, a little raise in price due to the tax imposed will result to a big fall in sales. This implies that, tax increment may not lead to increased level of revenues as expected and that’s why the government should be informed about price elasticity. Taxes and other charges results to an increment of the prices for the goods and services, due to this government need to be knowledgeable in assessing the demand reaction towards these changes to have an accurate estimate of the amount of revenue they will gain.

At some situations, consumers have no option than to pay any stated amount of money so as to acquire a certain quantity of a good that is perfectly inelastic demand. This can be very difficult for a consumer to satisfy these types of condition in a whole market. For instance, to any patient suffering from a deadly disease and relies on specific drugs can pay any price to get that prescription. Due to this, the government should intervene in such markets to ensure regulation and control exploitation of such consumers (McConnell, Brue, & Campbell, 2004).

Conclusion

In conclusion, business and economics is a social science which tries to give the desired satisfaction for needs and wants of human kind. In business part of it consumers tend to buy goods and services to satisfy their needs as it is their right too. Their purchase is based on the goods in question and their respective prices; that is why if the price changes the demand of the affected commodity will also adjust accordingly. This idea brings in the importance of the price elasticity into the businesses so as to achieve its set goals and objectives. To government it’s also vital information as it guides when the government is setting prices for its goods and services and when determining the percentage of indirect taxes to be added on goods and services.

Reference

Brent, J.R. (2008). Applied Cost- Benefit Analysis: (2nd ed.): Edward Elgar publishing.

Hirschey, M. (2009). Fundamentals of Managerial Economics. (9th ed.): Cengage Learning.

Maurice, S., & Thomas, C. (2008). Managerial economics w/ CD: (9th ed.): New York, NY: McGraw-Hill. ISBN: 007334656X

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McConnell, C.R., Brue, S.L., & Campbell, R.R. (2004). Microeconomics: Principles, Problems and Policies. (16th ed.): McGraw-Hill professional.

Sloman, J. (2006). Economics. (6th ed.): Financial Times Prentice Hall.

Vaidya, K.A. (2005). Globalization: Encyclopedia of Trade, Labor and Politics. (vol 2): ABC- CLIO

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