Discuss the importance to businesses of having a good knowledge of Essay

Discuss the importance to businesses of having a good knowledge of elasticity's for planning and pricing policies, using examples and diagrams as appropriate - Essay Example th a price elasticity of 1.5, a 10 percent increase in the price of a bar of bath soap would cause a 15 per cent drop in the quantity demanded of the product based on the formula E = ΔQ / ΔP. The demand is relatively elastic (the demand curve is somewhat flat) if it is greater than 1, such as the one shown in the graph below, and relatively inelastic if less than 1, such as 0.9. Cross elasticity of demand is used when one products affects another because they are either complements or substitutes. An example would be coffee and sugar which are complements because an increase in demand in coffee raises the demand for sugar. So instead of the quantity demanded of coffee changing as its own price changes, we measure the quantity demanded of coffee to a change in the price of sugar. If we take another example, such as a cross elasticity of 2.0 for PC in relation to a printer. If the price of computer printers fell 3 per cent, demand for laptop will rise 6 per cent because the cross price elasticity is -2. These products are complements. In case of substitutes, a drop in the price of Japanese cameras will cause the quantity demanded of American cameras to drop. 1.3 Income elasticity of demand. When an individuals income increases, his demand for a computer laptop, for example, increases if the product is a normal good. If it is an inferior good such as canned sardines, an increase in income will reduce the quantity demanded of sardines because the individual might prefer to consume steak or chicken instead. If the demand is very elastic - that is, the elasticity is much higher than 1.0, lets say 3.0 - any increase in the price of a commodity or service would result in a loss of revenues for the marketer. This is because a 10 per cent increase in price would trigger a reduction in quantity demanded of 30 per cent. On the other hand, if the firm reduces his price, this can result in a three-fold increase in the quantity demanded, and therefore he makes more