Applied Managerial Economics (Essay Sample)

Applied Managerial Economics
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Price elasticity of demand is used to determine the relationship between the price of a commodity and the quantity demanded. Price elasticity of demand also provides a clear calculation of the effect of the change in price on quantity demanded.
%change in quantity demanded
_________________________
% change in price
This equation can be used to calculate the effect of price change on quantity demanded and the amount of revenue the company receives before and after the price change.
For example, if we increase the price of an auto part from$1.00 to $1.20, and the daily sales falls from 500,000 to 250,000, the price elasticity of demand will be
-50 %/+20%
= (-) 2.5
The negative sign shows that the price of auto parts is inversely related to the quantity demanded. With this, the company can calculate the effect of price change on revenue.
In our example, the revenue at $1.00 is $500000($1 x 500000) it falls to $ 300000 after increasing the price ($ 1.20 x 250000)
The response of quantity demanded to a change in price varies considerably. If a large change in price results in little change in quantity demanded, the demand is considered relatively inelastic. If a small change in price results in a large change in quantity, the demand is considered relatively elastic. If the percentage change in price is equal to percentage change in quantity demanded, then the demand is considered unit inelastic. When the aggregate demand for a product does not vary when its price changes, then the demand is considered perfectly inelastic. On the other hand, a perfectly elastic demand means an infinitely small change in price lead to an infinitely large quantity demanded (Tellis, 1988).
Perfectly inelastic demand curve

Price demand
 P2
 P1

0 Q1 Quantity demanded
Here the demand remains constant for any value of price.
Perfectly elastic demand

Price
 P1 demand
 0 quantity demanded
Above the price P1, there is no demand, at price P1 the market demand equals the quantity demanded. Moreover, below the price P1the market would demand the quantity provided.
 Price
 P1
 P2 demand

 0 Q1 Q2 Quantity demanded
An increase in price leads to a decrease in demand.
Relatively inelastic demand curve
Price
 P1
 P2
Demand
 0 Q1 Q2 Quantity demanded
Proportionate change in demand from 0Q1 to 0Q2 is relatively smaller than the proportionate change in price from 0P1 to 0P2.
Unitary elastic demand curves

Price
 P1
 P2 demand
 0 Q1 Q2 Quantity demanded
The change in price 0P1 to 0P2 produces the same change in demand from 0Q1 to 0Q2. Therefore, the demand is unitary elastic.
To increase demand, regardless of how expensive you make your product, you must make the product as inelastic as possible. Unique features of a product, excellent services to customers, or world class marketing are some of the methods that can be used to make a product inelastic. Necessity goods tend to be inelastic; ...