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Topic 1: Price Elasticity of Demand

It is highly recommended that you review the Seminar presentation located in the Seminar Topics document under Course Resources before beginning the Discussion.

The law of demand states that a fall in the price of a product raises the quantity demanded for the product, whereas an increase in price leads to a decrease in quantity demanded for the product. The price elasticity of demand measures the extent of the responsiveness of the quantity demanded to a change in price. Demand for a product is elastic if the quantity demanded responds substantially to changes in the price, and the percentage change in quantity demanded is greater than the percentage change in price. Demand is inelastic if the quantity demanded responds only slightly to changes in the price, which indicates that the percentage in price is greater than the percentage in quantity demanded for a certain product.

However, the extent of responsiveness of quantity demanded to a change in price depends on the nature of a particular good or service in the market. The price elasticity of demand partly depends on the availability of close substitutes. When a large number of substitutes are available, consumers respond to a higher price of a product by buying more of the substitute the product and less of the relatively more expensive product. In addition, goods or services that are considered necessities tend to have less elastic (more inelastic) demand, whereas goods or services that are considered luxuries have more elastic (less inelastic) demand.

• Explain why the demand for the good or service provided by a firm is elastic or inelastic. How does the elastic or inelastic demand influence pricing decisions by the firm to maximize profit? What are the impacts of elastic demand and inelastic demand on total revenue?
• Provide examples on how the availability of close substitutes affects price elasticity of demand for a good or service.
• Give specific examples of necessities or luxuries, and explain how they affect price elasticity of goods or services.

Do the discussion first then do the response each posted below.

Posted 1

Class,

The price elasticity of demand is a measurement of how “elastic” the relationship of price and demand are for a particular good or service. This means; that as the price for something decreases, the demand will increase if it is elastic and it will be unaffected if it is inelastic. The elastic relationship applies to a lot of goods and services, especially when it is something someone wanted anyway and it happens to go on sale. This does rely heavily on how readily available the information about prices are.

For example, in healthcare most people simply go to the nearest hospital or urgent care when they need assistance. While some people will prioritize based on their insurance plan, distance likely reigns supreme as the determining factor in where someone receives their medical needs. If the pricing was available, this may change. However, another factor is that some services are emergencies and therefore the choice factor is removed for the expedience of survival. In this way, healthcare is an example of a service that is fairly inelastic both because of lack of information about pricing and for the need to survive being prioritized over price.

On the other side of the spectrum is energy drinks. Most energy drinks these days are made up of the same compounds and rely mostly on caffeine and sugar. While they may have differing tastes, it is reliance on the addictive properties of these two ingredients that makes them successful. So when one company drops the price of one of their energy drinks significantly, it would not be surprising to see a spike in their sales and a similarly sized drop in the sales of their competitors.

Posted 2.

A good or service for a firm is elastic or inelastic depending on how easily the product is to be substituted. If a product is highly responsive to price changes, it means the product is elastic. This means if the price went up, consumers would be less likely to purchase it than a product that is inelastic. Elastic products can be seen as luxury items such as nice vacations or the newest fashion. People want it, but it would be first off the budget if times became tough. In contrast, inelastic products are not sensitive to price change. These are necessary items such as milk and eggs, or other household staples like soap. These are products that people can’t live without despite financial hardships, so regardless of price, the demand for the product would still be there. Elastic demand on total revenue will be increased if prices on elastic products are decreased. If prices are increased for inelastic goods, revenue will increase because there will unlikely be a huge change in the amount purchased/ in demand.

Close substitutes for a product increase the product’s elasticity. This is because if a company raises its prices, the consumer could just buy a similar item for a cheaper cost. Close substitutes increase price sensitivity. An example with peanut butter is if Jiffy raises their price from $3 to $5 and Smuckers keeps their price at $3, people will shift their buying preferences to Smuckers because it is a close substitute for Jiffy and more affordable.

Necessities are things such as toiletries, toilet paper, and food. These can all be purchased at a pretty affordable level, and can all be found at the dollar store. These items are essential to maintain hygiene and function in society. Luxurious are items that people go out of their way to buy and fulfil excess enjoyment. This could be things such as vacations, buying boats, or fine dining. These are things everyone would love to do but don’t necessarily have to if it’s not in the budget. Necessary goods are considered inelastic because people must buy them. People don’t focus as much attention on them because they will have to purchase the item regardless if the price goes up a few dollars. Luxuries are more elastic because they can easily be forgone if prices become undesirable.

McConnell, C. R., Brue, S. L., & Flynn, S. M. (2018). Economics principles, problems, and policies (21st ed.). McGraw-Hill Education.

Posted 3

The demand for goods or services offered by a company might be elastic or inelastic depending on the responsiveness of quantity demanded to changes in the prices for the products and services. Elastic demand occurs when a price change leads to a significant change in the amount of goods and services demanded by the consumers. For instance, if a product is on sale, especially luxury products, the demand would increase. On the other hand, inelastic demand occurs when a change in prices leads to no or slight change in the quantity of goods and services demanded by the customers. You see this in essential products such as medication, electricity, gas, etc.

The elastic and inelastic demand has a significant impact on pricing decisions by the companies to maximize profits. When the demand for products is elastic, the firms will maximize profit by lowering prices to increase revenues, but when the price increases, the demand decreases, and revenues decrease (McConnell, Brue, & Flynn, 2018). In contrast, when the demand for products is inelastic, the pricing of the products and services will not be affected because the firm will only need to increase sales units to maximize profits (Beck & Lein, 2020). As a result, elastic demand will lead to lower total revenue because a slight increase in prices reduces the quantity demanded, while inelastic demand will lead to an increase in total revenues because an increase in prices does not significantly affect the total revenue).

The higher the necessity of a product, the less the elasticity of the demand for the product, such as medical drugs, utilities, food, etc. The prices for medical products and utilities do not impact the demand because it is necessary for day-to-day life. In contrast, luxurious products lead to increased demand elasticity, such as smartphones, designer purses, and first-class airfare, which are more susceptible to price fluctuation and when the customer is willing to buy.

References:

Beck, G. W., & Lein, S. M. (2020). Price elasticities and demand-side real rigidities in micro data and in macro models. Journal of Monetary Economics, 115, 200–212. Retrieved from https://doi.org/10.1016/j.jmoneco.2019.06.003