1) How Firms Can Use the Concept of Price Elasticity of Demand to
Increase Sales Revenue
Price elasticity of demand (PED) is a measure of how the quantity demanded of a
good or service responds to changes in its price. It provides critical insights into consumer behaviour, allowing firms to optimise pricing strategies and maximise revenue. Depending on whether demand is elastic or inelastic, firms can make informed pricing decisions to achieve their revenue goals.
For Elastic Demand (PED > 1)
When demand for a product or service is elastic, consumers are highly responsive to price changes. A small reduction in price can lead to a disproportionately larger increase in the quantity demanded, resulting in higher total revenue. Conversely, a price increase in such cases could significantly reduce sales volumes, harming revenue.
For Inelastic Demand (PED < 1)
When demand is inelastic, consumers are less sensitive to price changes. A price increase may lead to only a small decrease in quantity demanded, which can raise total revenue. Similarly, price reductions may not significantly boost sales, as consumers are not highly responsive to price cuts.
Product and Market Differentiation
Firms can use PED to identify market segments and tailor pricing strategies accordingly. For instance, businesses can charge higher prices to customer groups with inelastic demand and lower prices to those with elastic demand. This practice, known as price discrimination, helps maximise revenue by targeting different consumer sensitivities.
Enhancing Marketing Techniques
Understanding elasticity helps firms design effective promotions. Discounts and sales are more effective in markets with elastic demand, as consumers respond strongly to price reductions. Conversely, in markets with inelastic demand, firms may focus on enhancing perceived value rather than reducing prices.
By leveraging PED insights, firms can make strategic pricing decisions to enhance sales revenue while maintaining competitiveness in the market.
2) Using real world examples discuss the importance of price elasticity of
demand for governments when intervening in different markets.
Price elasticity of demand is a critical consideration for governments when
intervening in markets. It helps policymakers predict consumer responses to price changes resulting from taxes, subsidies, or regulations. Understanding PED allows governments to achieve their economic and social objectives effectively, whether the goal is to raise revenue, promote public welfare, or control market inefficiencies.
Taxation Policy Governments often impose taxes on goods and services to generate revenue. The effectiveness of such taxes depends on the price elasticity of the taxed goods. Products with inelastic demand, such as tobacco, alcohol, and gasoline, are commonly taxed because consumers are less likely to reduce their consumption even when prices rise, ensuring stable tax revenue.
Example - In the United Kingdom, high taxes on cigarettes are justified by their inelastic demand. While the primary objective is to discourage smoking, the steady consumption of cigarettes ensures that the government collects substantial tax revenue, which can be used to fund public health programs.
Subsidies to Encourage Consumption
Subsidies are provided for goods and services where the government wants to encourage consumption or production. The effectiveness of subsidies depends on the elasticity of demand. For goods with elastic demand, subsidies can lead to significant increases in consumption.
Example - Norway has heavily subsidised electric vehicles (EVs) to make them more affordable. The subsidies reduce the effective price of EVs, encouraging more consumers to switch from conventional cars to environmentally friendly alternatives. This strategy leverages the relatively elastic demand for EVs, especially among environmentally conscious buyers.
Price Controls and Consumer Protection
Governments may set price ceilings (maximum prices) or price floors (minimum prices) to protect consumers or producers. Price ceilings are typically applied to essential goods with inelastic demand to prevent exploitation, while price floors are used to ensure fair income for producers.
Example of Price Ceiling - Rent control in urban areas is implemented to protect
tenants from exorbitant rent increases. Since housing is a necessity, demand is inelastic, and without intervention, landlords could exploit tenants by significantly raising rents. While rent control achieves affordability, it may also lead to housing shortages if landlords withdraw properties from the market. Example of Price Floor - In India, the government sets a minimum support price (MSP) for crops to protect farmers from price volatility. This policy ensures farmers earn a minimum income even when market prices fall below sustainable levels. Regulation of Essential Goods and Services For goods and services with inelastic demand, such as healthcare, utilities, and education, governments may intervene to regulate prices or ensure access. This prevents monopolies or oligopolies from exploiting consumers.
Example - During the COVID-19 pandemic, governments in several countries
imposed price caps on essential medical supplies like masks and ventilators to ensure affordability and prevent price gouging. The inelastic demand for these items during the crisis justified strict regulation.
Market Intervention to Address Negative Externalities
When addressing negative externalities, such as pollution or unhealthy consumption habits, governments use taxes or regulations. The effectiveness of these interventions depends on the elasticity of demand for the targeted goods.
Example - In 2014, Mexico introduced a tax on sugary drinks to combat rising
obesity rates. The tax aimed to reduce consumption by increasing prices. Studies showed that demand for sugary drinks was elastic enough that the tax led to a significant decline in sales, particularly among low-income households.
