Research Report: the Price Elasticity of Demand

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Managerial Economics
Research Report: The Price Elasticity of Demand

The Price Elasticity of Demand:

1. Introduction:
Price elasticity of demand is an economic measure that is used to measure the degree of responsiveness of the quantity demanded of a good to change in its price, when all other influences on buyers remain the same.

Elasticity of demand helps the sales manager in fixing the price of his product, deciding the sales, pricing policies and optimal price for their products. The evaluation of this measure is a useful tool for firms in making decisions about pricing and production which will determine the total revenues for the firms.

In our research, we will discuss about price elasticity of demand, we will explain how firms can use the price elasticity of demand for Goods and services to decide on sales, setting pricing policies and determining the optimal price to maximize revenues.

2. Analysis:
Before analyzing the effect of price elasticity of demand on change in a firm’s revenue, it is significant to analyze the price elasticity of demand itself.

The price elasticity of demand reflects the relation between price and quantity. An elastic demand means that the quantity demanded is relatively responsive to changes in price i.e. Elasticity > 1. It is calculated as:

Price Elasticity of Demand = % ∆ Quantity demanded
% ∆ Price

Sales:
After the analysis of price elasticity of demand we can identify the relationship between the prices and firm’s revenue. Given the price elasticity of demand facing the firm in the relevant range of production, how would a change in the price of the good affect a firm's revenues? Remember, if a firm raises prices they reduce sales (for a typical downward sloping demand curve) and the firm increases sales when there is a reduction in prices.

A firm's revenues equals the total sales of a good sold times the price charged:
Total Revenue = Price x Quantity
TR = P x Q

The effect on total revenue is a factor of the three parts: 1. Change in revenue as a result of change in price on the condition ceteris paribus. 2. Change in revenue as a result of change in volume of sale on the condition ceteris paribus. 3. Change in revenue as a result of both change in volume of sale and change in prices:

The relationship between Price elasticity of demand and total revenue can be also be described as: 1. When the price elasticity of demand for a good is perfectly inelastic (Ed = 0), changes in the price do not affect the quantity demanded for the good; raising prices will cause total revenue to I ncrease. 2. When the price elasticity of demand for a good is relatively inelastic (-1 < Ed < 0), the percentage change in quantity demanded is smaller than that in price. Hence, when the price is raised, the total revenue rises, and vice versa. 3. When the price elasticity of demand for a good is unit (or unitary) elastic (Ed = -1), the percentage change in quantity is equal to that in price, so a change in price will not affect total revenue. 4. When the price elasticity of demand for a good is relatively elastic (-∞ < Ed < -1), the percentage change in quantity demanded is greater than that in price. Hence, when the price is raised, the total revenue falls, and vice...
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