Applications of Elasticity Concepts (Firms)

• Profit


  Total Revenue - Total Costs
• Aim of firms in markets

  Profit Maximise
• Maximise Profit


  Maximise TR - Minimise TC
• Ways to increase Total Revenue

  • Price Decision
  • Non-price Decision
• Price Decision


  Decisions regarding intended effects or consequences of price adjustments
• Non-price Decision


  Decisions including adjusting output, product placement and product development
• When Demand is price elastic

  Firms should lower prices
• When price decreases


  TR increases
• Salience bias


  Draw buyers' attention to the percentage reduction in the price of the good or enable consumers to exploit the reduction in price with other substitutes, causing them to ignore other expects such as quality
• Loss aversion


  Firms can highlight the limited time of the reduced price as well as emphasise on the limited stocks available, leading to consumers making decisions more quickly and in favour of producers
• When Demand is price inelastic


  Firms should raise prices
• When price decreases


  TR decreases
• PED


  Price Elasticity of Demand
• How can a firm adjust the PED value for its good?

  1. Reduce the substitutability of its product

  2. Product innovation

  3. Advertising to create more awareness and preference for the product
• Product differentiation


  Creating physical or perceived differences between the firm's product and other substitutes
• When demand is price inelastic

  Firm should increase the price of the good so that total revenue increases
• YED


  Income Elasticity of Demand
• When incomes are rising

  Firms would increase the output (production) levels of normal goods and decrease the output levels of inferior goods
• When incomes are falling

  Firms would reduce the output of normal goods and increase output of inferior goods
• For normal goods, expected 10% increase in demand


  Rise in total revenue of the firm by Q0ABQ1, if firms raise output by Q0Q1
• Without YED values


  Firm may have increased output by less or more than optimal level, resulting in less revenue or excess stocks
• For inferior goods, when incomes rise


  Firms may cut down output by less than optimal level, resulting in surpluses
• For inferior goods, when incomes fall


  Firms may cut down output by more than optimal level, resulting in insufficient stocks
• XED


  Cross Elasticity of Demand
• When XED is positive


  Goods sold by the firm and that of other firms are substitutes
• When XED is negative


  Goods sold by firms and that of other firms are complements
• When price of a substitute good increases

  Demand for goods with positive XED increases, firm should raise output
• When price of a complementary good increases


  Demand for goods with negative XED decreases, firm should reduce output
• Knowledge of YED and XED enables firms to adjust their output appropriately when income or prices of other goods change