Using Elasticities in Managerial Decisions
The concept of price elasticity of demand has important practical applications in managerial decision-making. A business man has often to consider whether a lowering of price will lead to an increase in the demand for his product, and if so, to what extent and whether his profits would increase as a result thereof. Here the concept of elasticity of demand becomes crucial.
Knowledge of the nature of the elasticity of demand for his products will help a business to decide whether he should cut his price in a particular case. Such knowledge would also help a businessman to determine whether and to what extent the increase in costs could be passed on to the consumer. In general for items those whose demand is elastic it will pay him to charge relatively low prices, while on those whose demand is elastic, it would be better off with a higher price. A monopolist would not be able to increase his price if the demand for his product is elastic.
In practice, an accurate estimate of the probable response of volume of sales to price changes is extremely difficult. Moreover, the cost of the statistical analysis required may in some cases, exceed the benefit especially when uncertainty is great or when the volume is too small to provide a reason also return on the amount spend on research. The subjective judgment of certain managers, beyond on years of experience, sometimes exceeds in accuracy the best of the present statistical techniques. Uses of price elasticity can be point out as below:
- Price distribution
A monopolist adopts a price discrimination policy only when the elasticity of demand of different consumers or sub-markets is different. Consumers whose demand is inelastic can be charged a higher price than those with more elastic demand.
- Public utility pricing
In case of public utilities which are run as monopoly undertakings e.g. elasticity of water supply railways postal services, price discrimination is generally practiced, charging higher prices from consumers or users with inelastic demand and lower prices in case of elastic demand.
- Joint supply
Certain goods, being products of the same process are jointly supplied, e.g. wool and mutton. Here if the demand for wool is inelastic compared to the demand for mutton, a higher price for wool can be charged with advantage.
- Super Markets
Super-markets are a combined set of shops run by a single organization selling a wide range of goods. They are supposed to sell commodities at lower prices than charged by shopkeepers in the bazaar. Hence, price policy adopted is to charge slightly lower price for goods with elastic demand.
- Use of Machine
Workers often oppose use of machines out of fear of unemployment. Machines need not always reduce demand for labor as this depends on price elasticity of demand for the commodity produced. When machines reduce costs and hence price of products, if the products demand is elastic, the demand will go up, production will have to be increased and more workers may be employed for the product is inelastic, machines will lead to unemployment as lower prices will not increase the demand.
- Factor pricing
The factors having price inelastic demand can obtain a higher price than those with elastic demand. Workers producing products having inelastic demand can easily get their wages raised.
- International Trade
- A country benefits from exports of products as have price inelastic demand for a rise in price and elastic demand for a fall in price.
- The demand for imports should be inelastic for a fall in price and elastic for a rise in price.
- While deciding whether to devalue a country’s currency or not, price elasticity of demand for a country’s exports would be an important factor to be taken into consideration. If the demand is price elastic, it would lead to an increase in the country’s exports and devaluation would fail to achieve its objective.
- Shifting of tax burden
It is possible for a business to shift a commodity tax in case of inelastic demand to his customers. But if the demand is elastic, he will have to bear the tax burden himself, otherwise demand for his goods will go down sharply.
- Taxation policy
Government can easily raise tax revenue by taxing commodities which are price inelastic.