Price Elasticity of Demand and Supply

Topics: Supply and demand, Price elasticity of demand, Price elasticity of supply Pages: 4 (1112 words) Published: January 22, 2011
Q. Discuss how a supplier of a product that is currently fashionable might use both of these concepts in making price and output decisions.

Price Elasticity of Demand

The price elasticity of demand measures the sensitivity of the quantity demanded to price. The price elasticity of demand is the percentage change in quantity demanded brought by a 1 percent change in price. The value of price elasticity of demand for a normal good must always be negative, reflecting the fact that demand curves slope downward because of the inverse relationship of price and quantity.

The price elasticity of demand can be an extremely useful piece of information for business firms, nonprofit institutions, and other organizations that are deciding how to price their products or services. It is also an important determinant of the structure and nature of competition within particular industries.

To see why a business might care about the price elasticity of demand, let’s consider how an increase in price might affect a business’s total revenue, that is, the selling price times the quantity of product it sells. One might think that when the price rises, so will the total revenue, but a higher price will generally reduce the quantity demanded. Thus, the ‘benefit’ of the higher price is offset by the ‘cost’ due to the reduction in the quantity, and business must generally consider this trade-off when they think about raising a price.

Economists has classify the possible range of values for price elasticity of demand as ‘Perfectly Inelastic Demand’, ‘Inelastic Demand’, ‘Unitary Elastic Demand’, ‘Elastic Demand’, and ‘Perfectly Elastic Demand’. In the process of helping a supplier of a product that is currently fashionable to decide price decision, we must first identify the classification that the product is in right now as being ‘fashionable’.

Firstly, we can safely assume that the product is not in the classification of ‘Perfectly Inelastic’, ‘Perfectly...
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