Why Businessmen Raise Prices When Facing Inelastic Demand

Topics: Supply and demand, Price elasticity of demand, Elasticity Pages: 4 (1043 words) Published: July 11, 2012
Why is it that a profit maximizing businessman would always raise prices when facing an inelastic demand curve but might or might not raise price when facing an elastic demand curve? Explain and justify your answers in detail.

Elasticity and profit maximization behavior
When facing an inelastic demand curve, a profit maximizing businessman would always raise price because increase in price will bring about increase in total revenue. On the other hand, when facing an elastic demand curve, he might or might not raise price because increase in price will bring about decrease in total revenue.

According to the law of demand, there is an inverse relationship between the quantity demanded of a particular good and its price. The degree to which this change in price affects the quantity demanded of the good in a given period is measured by the price elasticity of demand. It is calculated between two points on a given demand curve by dividing the percentage change in quantity demanded by the percentage change in price. This value is always negative but the absolute value is used. When the result from the elasticity calculation is greater than 1, the demand is elastic. If it is less than 1, the demand is inelastic. If it is equal to 1, the demand is unitary. An elastic demand curve gives a situation where response of the quantity demanded of a good to a change in price is highly significant. This is found in goods that has substitutes such as coke and pepsi. A slight increase in price of coke brings about a huge decrease in quantity demanded of coke all other things being equal. Consumers will buy more of the substitute, pepsi. Since revenue(R) is the product of quantity (Q) and price (P). The revenue from coke will decrease as a result of the price increase. R = Q × P

For example, if a profit maximizing businessman increases the price of an elastic goods from $10 to $12, and the quantity demanded decreases from 16pieces to 10pieces. The price elasticity of...
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