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Law of Diminishing Returns
The law of diminishing returns states that “an increase in one input without making adjustment to other inputs results in a reduction in the total output” (Talent, 2010). In the case of studying late in the night, time is the only input being increased. Concentration may diminish as a student extends study time without balancing other inputs.
The situation is similar to that of occupying an office space, a desk, or student cubicle. With additional people using the unadjusted space, the working environment becomes congested for the student, or worker.
Productivity is the average output per worker. Productivity may be lower but total output still increases because of the number of workers. First, the average output per worker declines (after the 5th worker), and then it reaches a point when an additional worker does not increase total output. Lastly, the total output starts to decline for any additional worker using the same space after the 11th & 12th worker (Talent, 2010).
In the working space situation, the only input being increased is the number of workers. The solution to a high level of productivity would be to balance all the inputs used by the workers. These include “working space, equipment, tools, and other resources” (Talent, 2010). In the workers’ case, other resources may include support, and motivation.
We must be concerned about the right ratio of inputs to maximize productivity.
Market equilibration process
Market equilibrium is a condition in which consumer demand equals the quantity supplied. The point of intersection of the supply and demand curves is the market price. A shortage or a surplus may exist when the market is not in equilibrium (Talent, 2010).
Market forces will adjust demand and supply quantities through the price to bring the market back to equilibrium. This is the natural process that is likely to take place unless an external influence interferes with the balancing process (Talent, 2010).
A shortage of oranges results in orange farmers demanding a higher price. Producers include the additional cost in the final output. The consumer buys the orange at a higher price. In this case, a higher demand than supply results in higher prices. Higher prices adjust the demand to a new lower level (Talent, 2010).
New findings about the benefits of orange juice increase consumer preference for the product. Demand increases because consumers want more of the discovered benefits. Manufacturers are motivated to increase prices because consumers have discovered an additional value from the product.
Orange farmers motivated by high prices produce more oranges which may increase supply. Prices may decrease to a level that meets the equilibrium requirements. One can identify the existence of equilibrium when the shortage no longer exists (Talent, 2010).
Understanding the shifts in demand and supply are necessary for business planning (Talent 2010). For example, a business can plan its pricing and production through inventories such as having a large stock when anticipating an increase in prices.
Price elasticity of demand
Price elasticity of demand “explains how far demand stretches in response to a change in price” (Talent, 2010). In the Pizza City business, revenues declined because of raising the price of pizza by $2 (Talent, 2010).
When prices are raised, customers consider alternatives. Products that give customers no alternative are inelastic to price. Products that have alternatives are elastic to price. In the Pizza City case, customers can choose to buy from other restaurants with lower prices, cook their own food, or buy other products (Talent 2010).
In the Hammerstein medication case, he has no alternative but to purchase the medication. The demand for medication is inelastic to price (Talent, 2010). For a particular company, it may depend on the existence of manufacturers producing a similar medication.
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For a product with an inelastic demand, the business should consider increasing revenues by increasing prices. For a product with an elastic demand, the business should consider increasing revenues by lowering prices (Talent, 2010).
The coefficient of price elasticity is used to determine how much one should lower the prices to increase revenues. The coefficient is obtained by dividing the change in quantity sold by the change in price within the same period (Talent, 2010).
Using absolute values, a product with a coefficient that ranges between 0 and 1 is inelastic, and a coefficient >1 is elastic.
Calculating price elasticity of demand transcript
The principle of price elasticity states that “the quantity demanded by consumers varies at different prices for different commodities” (Talent, 2010).
The coefficient of price elasticity is used to determine whether to lower or raise a price to increase revenues.
The formula involves dividing the percentage change in quantity sold by the percentage change in prices.
In the Pizza City case, prices were lowered from $10 to $9. Quantity sold increased from 100 to 140 pizzas a day (Talent, 2010).
The percentage change in quantity sold is got by dividing the change in quantity sold by the average of quantity sold.
Coefficient of elasticity = 33% divided by -11% = -3. This is relatively elastic to price changes because it is greater than 1 in absolute values.
The interpretation states that an absolute value that is greater than 1 is elastic. Pizza City increased sales by 33% by lowering the price by 11% (Talent, 2010).
Kurtis Jelly Donuts have a price elasticity coefficient of 0.28. It is relatively inelastic because it falls between 0 and 1 in absolute values (Talent, 2010). Kurtis Jelly Donuts should increase revenues by increasing prices.
The coefficient of price elasticity is useful in making pricing decisions. Businesses should increase prices for inelastic products, and lower prices for elastic products to maximize revenues.
Talent (Speaker). (2010). Diminishing marginal returns, productivity, production theory [DVD]. University of Phoenix.
Talent (Speaker). (2010). Market equilibrating, supply and demand [DVD]. University of Phoenix.
Talent (Speaker). (2010). Price elasticity, revenue [DVD]. University of Phoenix.
Calculating price elasticity of demand [DVD]. (n.d.). University of Phoenix.