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Price Elasticity of Demand Role in Economics Essay

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Updated: Apr 17th, 2020

Price Elasticity of Demand monitors the pace of reaction to quantity demand owing to change in prices. Price elasticity of demand is used to establish the indifference of demand to price alterations. The higher the price elasticity the more customers react to price alterations (Krugman, 2009).

High price flexibility means that the demand of an item or service has increased because supply is insufficient to satisfy the market and therefore customers will have to cough more money than usual and they may be forced to buy the said item in a smaller quantity just to make sure all customers have been given equal opportunity to purchase the crucial commodity that is required on a daily basis.

When supply of a given product or service is insufficient those customers that purchased that product or service while it was still plenty have an upper hand because they have enough reservations to last until the situation stabilizes.

Customers who buy commodities in small quantities fill the pinch when the commodity that they require in their daily lives has become scarce and when they finally get it the price is almost double the usual price. On the other hand, if the price of the same commodity or service is reduced customers will buy more of that item in bulks.

Price elasticity is usually negative but experts don’t pay attention to the negative sign which can result in vagueness. The lone merchandise that has positive PED are the ones that don’t comply with the rules to the law of demand and supply.

Demand for an item is said to be inflexible if the PED is less than one. This means that price fluctuations have a very minimal impact on the demand of an item. On the contrary demand of an item is perceived to be flexible if the PED is more than one meaning that price fluctuations have impacted greatly on the quantity demand of an item.

There are several ways that can be used to check for price elasticity and they are namely (1) Test markets, (2) Analyzing previous historical sales records and (3) Analyzing the conjoint (Frank, 2008).

PED is calculated by dividing the proportion of the change in demand by the proportion of change in price. The other name for this gauge of flexibility is own-flexibility of demand for an item in the market.

This flexibility in demand with deference to change in price of a given item is used to compare that item to the elasticity of demand brought by price alterations of another item in the market. The other method of gauging flexibility is referred to as cross-price flexibility of demand. When the variance between two prices or quantities swells, the accuracy of PED declines.

The general reason that can influence PED is the customers’ compliance and eagerness to boycott the purchase of a given item after its price and demand has changed and thereby look for an alternative item until the price and demand resume to normal. The first element that may influence PED is the existence of alternative items. Flexibility will be higher if there are many alternative items and they are easily accessible because customers can swap one item with another.

This means that if there are no alternatives, swapping will be limited, and therefore, PED will be inelastic. Secondly, if the percentage of revenue for customers is high as reflected on the cost of items, then elasticity will be high. If items only impact on expenses, their effect on revenue will be very minimal, thereby demand will not be flexible. When people require a certain item on a daily basis or more often then flexibility will be low because people will purchase that item regardless of its cost.

The period that price alterations last is very important in determining PED. According to Harold (2001), this is because if price fluctuations last for a longer period than expected customers will look for alternative items to fill the gap created by a given item.

When an item or a service is available in several varieties depending on the taste of the customers and another item or service in the same market is available but it does not address the taste of the customer the one with options will be purchased more than the one with a fixed option hence flexibility of demand will increase and the latter will have a reduced flexibility of demand.

Customers tend to be devoted to a given brand or a service provider in the market because of their background and emerging hurdles. This devotion is owed to the history of the manufacturer or service provider in question. Some people stick to certain brands even when their cost is higher and also their quality does not conform to industry standards whereas they are aware of another branch that is relatively cheaper and of better quality and more convenient.

For instance, there are many mobile subscribers in the US with different call rates but it’s surprising to find the network that has the highest call rates and the weakest network overcrowded and another one that offers the lowest call rates and has a stronger network has very few customers. This devotion to a brand name or a service provider will either decline or improve the flexibility of demand and price.

John (2006) argues that the party that caters for expenses incurred in a purchase may directly or indirectly influence the flexibility of demand. The customer’s taste of products and services is enhanced by the purchasing party. In general, customers will consider the prices of a commodity or a service when they know they will personally cater for their expenses and thereby will evaluate brands and service providers to identify the one that best suits them.

According to Krugman (2009), Companies should, therefore, consider referring to price flexibility of demand to help them improve their market share and achieve their missions. Organizations that deal with manufacturing commodities for human consumption should ensure that their products are available in several options. This will make customers feel that their needs are given the first priority and may influence them to develop a strong bond with a given brand that is based on trust and reliability.

There is no known customer who would want to be associated with a brand name whose integrity has not been verified or a service provider who is renowned for providing services that have been under public scrutiny. This can be avoided by creating a channel through which customers can forward their complaints and acknowledgments.

The information provided by the customers should be analyzed to see what should be amended to improve the quality of a product or a service. Honesty is very vital in any business and can impact on the flexibility of demand either negatively or positively but the impact here depends on whether the company is honest or lacks honesty. The same relates to a service provider.

There are cases where manufacturers have been found lying to their customers about the ingredients of their products. This may increase the sales of that particular product for a short while but when the customers come to know about it in one way or another, public trust on that particular brand will diminish. This is because public devotion to a brand takes a very long period to grow but it takes a very short period to deteriorate almost at the blink of an eye.

Wrong fabrications of product descriptions will imply an insult to the customer considering that such products come with very high price tags because they claim to contain only ingredients that are healthy or are essential to human health (Andrew, 2007). Service providers too have their share in this vice. There are service providers who have been found to inject more losses to their customers even when they insist they know how to handle the issue at hand.

For instance, when a car owner drives into a garage to have his/her car evaluated by a mechanical to repair or replace any damaged or lost parts. The customer who owns that particular vehicle expects to walk out of that garage when the car condition has been fully attended and he/she is willing to pay the cost of repairing his vehicle.

If after leaving the garage the customer still experiences the same problem that was diagnosed by the mechanic, it means the mechanic did not deserve the payment he received from the motorist because the problem is still persistent.

The above-mentioned situation may not affect the said mechanic’s flexibility of demand at the moment but because motorists consult each other concerning the reliability of their automobile technicians the mechanic will stand to lose his customers. This loss will depend on the number of people who criticize his competence which in return will impact negatively on the flexibility of demand.

Manufacturers can also influence the flexibility of demand and price by making their products in portions that can be affordable to low-income earners.

This is because most companies don’t realize the potential in low-income earners because they form the majority of the human population world wide. Reputable companies have a wide range of products and services that are tailored to be compatible with the customer’s purchasing power. These companies reckon that profits can also be obtained by incorporating low-income earners into the market share.

In most cases, the desire to purchase is limited by one’s earnings, and therefore, people prefer to purchase products that are affordable to them (Frank, 2008). The manufacturers should look deeply into these problems because they influence the flexibility of demand and price, which might cause companies to incur unnecessary losses. The best way to solve this problem is to slash the quantity and prices of their products and therefore absorb low-income earners into their market share.

References

Andrew, G., 2007. Foundations of Economics. Oxford University Press: UK.

Frank, R., 2008. Microeconomics and Behavior. 7th Ed. McGraw-Hill Inc: USA

Harold, V., 2001. Entertainment Industry Economics. 5th Ed. Cambridge University Press: UK.

John, S., 2006. Economics. Financial Times. Prentice Hall: Upper Saddle River, NJ.

Krugman, W., 2009. Microeconomics. 2nd Ed. Worth Publishers: New York.

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