DQ2: What significance, if any, should managers give to the Price and Cross Price elasticity of demand in determining the price for a particular commodity?
Price elasticity is the measurement of the responsiveness of demand to changes in the commodity’s price. It gives an idea to the managers to determine the price for a particular commodity. If there is a change in price, then the quantity demanded also changes. Price elasticity shows the ratio of proportional change in quantity demanded for responding a change in price (Boyesand Melvin, 2013). In other words, price elasticity is the percentage change in demand with respect to the percentage change in the price of the same products. Price elasticity guides the managers to determine the change in demand on the changes in prices. It also helps the firms to decide the profits after charging the particular price that crucial to make better pricing decisions (Gratton-Lavoie, C. and Stanley, D. (2009). It is crucial for the marketers to understand the price changes and their impact on the market demand. This concept is known as the elasticity of demand. The elasticity analysis is useful for the management to estimate the market reaction to make pricing decisions (Hall, R. E. and Lieberman, M.(2009).
Managers increase the demand for a particular commodity by lowering its price that may result in an increase in profit. However, there may be the possibility of less demand than proportionate to price fall that may affect the profits. Therefore, it is essential for the managers to know the elasticity of demand to make the decision whether to decline or raise the price of the commodity or to shift the extra cost to the customers through high prices. Inelastic demand is when the quantity bought doesn’t change as much as the price does, whereas elastic demand is when the quantity bought changes large due to a change in price. Generally, the commodities which have inelastic demand, the managers need to fix high prices, whereas the products having elastic demand require a low pricing (Besanko and Braeutigam, 2010). However, necessity goods are more insensitive to the price elasticity because people prefer to buy these products continuously despite the increase in price.
On the other hand, cross price elasticity is an economic concept that is used to determine the responsiveness of the demand of one commodity on the change in the price of another commodity. Substitute goods like tea and coffee can be used in place of one another. For this commodity, the demand for a commodity depends on the price of its substitute(Belleflamme and Peitz, 2015). A fall in price of one commodity can decrease the demand of substitute product and an increase in the price of one commodity can raise the demand of its substitute. So, all these scenarios for the commodities show that the changes in prices in one commodity may influence of demand of that commodity, complementary goods and substitute products. The managers can use this aspect in determination of the price of the commodity. They fix the prices accordingly that could lead to increase the demand of products for the company (Besanko and Braeutigam, 2010). Substitute goods show positive cross price elasticity of demand as it is crucial for the managers to consider the cross price elasticity to determine the price of one commodity to influence the demand for another commodity.
At the same time, complementary goods like tea and sugar, automobiles and petrol, etc. are used together to satisfy a want. These goods show a negative cross price elasticity and have the inverse relationship as if the price of a commodity decreases, the demand for another commodity increases. So, if the management wants to increase the demand for another commodity, it needs to focus on the decline in the price of first commodity (Rios, et al. 2013). It means if there is low demand of tea, then management can change in price of sugar to increase the demand of tea. Cross price elasticity shows this relationship as the situation of complementary goods indicates price elasticity behavior. However, it shows a negative cross price elasticity because the price of one commodity reduces the demand of another commodity in the market. Therefore, managers can use cross price elasticity to determine prices to sell their goods (Moon, 2013). Products with no substitutes can be sold at higher prices because there is no cross-elasticity to consider. It is because there will be no impact on demand of this product on change in price of any product. But, incremental price changes can be possible to achieve the desired level of demand and related price of the commodity. At the same time, the price of complimentary goods can be based on cross-price elasticity. For instance, if the firm predicts that future demand of complementary goods like printer ink will increase, then it can reduce the price of printers to sell them as soon as possible. Also, the price elasticity and cross price elasticity are significant for the management to develop strategies to reduce its exposure to the risks related to price changes by other firms like an increase in price of complementary goods or reduction in the price of the substitute goods (McEachem, 2016).
So overall, it can be stated that price elasticity and cross price elasticity of demand are significant for the managers in determining the price of a particular commodity. Both aspects show a valuable relationship between the changes in price and changes in demand that is crucial for the firms to increase revenues and profits. It is because changes in prices cause changes in demand of a particular commodity that is significant for the firms to enhance their sales and profitability (Oosterbaan, et al. 2012). By making changes in prices of their products, firms can make the change in demand of the similar or other products from a marketing perspective that contributes to their revenues and market share. Therefore, it can be concluded that managers should give significance to price and cross price elasticity of demand in price determination for the commodity.
- Belleflamme, P., and Peitz, M. (2015) Industrial organization: markets and strategies. UK: Cambridge University Press.
- Besanko, D. and Braeutigam, R. (2010) Microeconomics. USA: John Wiley and Sons.
- Boyes, W., and Melvin, M. (2013) Fundamentals of economics. USA: Cengage Learning.
- Gratton-Lavoie, C. and Stanley, D. (2009) Teaching and learning principles of Microeconomics online: An empirical assessment. The Journal of Economic Education, 40(1), pp.3-25.
- Hall, R. E. and Lieberman, M.(2009) Microeconomics: Principles and Applications. Cengage Learning.
- McEachem, W. A. (2016) Microeconomics: A Contemporary Introduction. USA: Cengage Learning.
- Moon, M.A. (2013) Demand and Supply Integration: The Key to World-Class Demand Forecasting. USA: FT Press.
- Oosterbaan, M.S., Steveninck, T.D.R.V. and Windt, N.V.D. (2012) The Determinants of Economic Growth. New York: Springer Science and Business Media
- Rios, M. C., McConnell, C. R., and Brue, S. L. (2013) Economics: Principles, problems, and policies. UK: McGraw-Hill.