Business relevance of elasticity estimates

How are the estimates collected?

Sample surveys - of consumers e.g. for PED and YED. Past records from within a company e.g. PES. Competitor analysis - e.g. XED

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What are the limitations of elasticity data?

The data are estimates - they are not exact figures, since there may be some inaccuracies in how the data has been collected. Over time, there could be factors other than those in the elasticity calculations that affect demand or supply of a product.

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PED information is widely used by businesses when ..

pricing their products in the market

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Most mainline rail and urban bus companies, tour operators and telephone services providers seek to maximise their revenue by?

Charging peak and off peak fares or rates.

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If PED is inelastic for a product, should firms reduce or increase price in order to increase revenue

Increase

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If PED is elastic for a product, should firms reduce or increase price in order to increase revenue?

Reduce

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Firms can use PED to predict the effect of a change in price on?

The total revenue and expenditure of a product.

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Firms can use PED to predict the likely price volatility in a market following changes in supply - this is important for?

Commodity producers who may suffer big price movements from time to time.

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Firms can use PED to predict the effect of a change in an indirect tax on ?

Price and quantity demanded and also whether the business is able to pass on some or all of the tax onto the consumer.

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Information on PED can be used by a business as part of a policy of?

Price discrimination e.g. peak and off peak travel

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Use of YED. In most economies, real disposable incomes tend to rise over time, what is the business significance of this?

Firms who produce goods and services with a positive and high YED can expect to do well in the future. UK - living standards increasing - growth in market for service sector products e.g. holidays.

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When economies face uncertain short term economic prospects or even recession, then demand for income elastic products will fall. Why is this?

Consumers are forced to substitute their demand towards inferior goods and services.

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Products, however, with a low YED are _____ likely to be affected by either a rise or fall in living standards.

Least

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Use of XED. Where there are close substitutes and hence a high positive XED, firms are tempted to?

Cut their own prices in order to steal market share from their rivals

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Give an example of this occurring in practice.

Low-cost airlines, TOCs and bus companies that operate on identical routes.

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Why is increasing prices in such markets a dangerous strategy?

Market share can be quickly lost and is invariably difficult to regain without resorting to heavy price reductions.

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In highly competitive markets, where brand names carry substantial value, many businesses spend huge amounts of money on persuasive advertising and marketing. What aims are there behind this?

Attempting to shift the demand curve for a product and also build consumer loyalty. When consumers become habitual purchasers of a product, XED against rival products will decrease - this reduces the size of the substitution effect.

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A reduction in the size of the substitution effect will mean that?

Demand is less sensitive following a price change - the result is that firms may be able to charge a higher price, increase total revenue and achieve higher profits.

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Use of PES. PES is always positive/negative/inverse?

PES is always positive - a reflection of the positive relationship between price and quantity supplied.

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In many types of businesses, supply is price ______ in the short term as it is often difficult to switch resources into a market.

Inelastic

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Main exception to this is where?

It is practical and economic for firms to hold stocks in anticipation of a price rise. So, if a price rise is expected, firms are advised to have good stock availability.

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Over time, supply is likely to be more price _____ in the longer term as resources can be re-allocated to respond to the increase in market price.

Elastic

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In general, firms will try to make their supply as?

Elastic as possible, in hope they can cash in on a rise in prices by selling more of their product.

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If prices are falling, an elastic supply will enable them to?

Move resources away from such products and into alternatives where the normal relationship between a change in price and a change in quantity supplied holds true.

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Business relevance of elasticity estimates

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