Demand Analysis: Price Elasticty
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Price Elasticity and Decision Making
All consumers should aware themselves of the factors involved with price elasticity and how the traits potentially impact their purchases and personal or commercial budgets. Commercial firms have the problem of managing price elasticity with their products and prices and governments have a constant problem of determining taxes from price elasticity. I used three examples to attempt solving how firms manage their products with price elasticity factoring with Proctor & Gamble, the oil, and airline industries. I used government examples of how the attempts to collect data to formulate their policies for taxation on elastic and inelastic products while also describing how the US Postal Service uses price elasticity to compete with corporate competition. Exposure to these factors of price elasticity will generate consumers’ awareness of firms and governments role to determine goods or services at a particular price.
Submit a paper of approximately 1,500 words answering the following question: Analyze why the concept of price elasticity important to (a) firms and (b) government?
Price Elasticity is the measure in responsiveness of consumers to changes in the price of a product or service. The evaluation and consideration of this measure is a useful tool in firms making decisions about pricing and production, and in governments making decisions about revenue and regulation. “Price Elasticity is impacted by measurable factors that allow managers to understand demand and pricing for their product or service; including the availability of substitutes, the consumer budgets for the product or service, and the time period for demand adjustments.” The proper consideration of Price Elasticity allows managers to set pricing such that the effect on Total Revenue is predictable and adjustments to production are timely. The concept of Price Elasticity is employed in the management of commercial firms and government.
Commercial firms use Price Elasticity to manage pricing and production decisions, especially in industries where the growth in sales and revenues are the primary measure of a firm’s success. Knowledge of the Price Elasticity for a product or service enables managers to determine the pricing strategy required to get the sales results desired. For example, a firm with a product with a relatively high elasticity would know that a large sales increase can be created with a small price decrease. Conversely, a firm with an inelastic product knows that changes in pricing would have minimal effect on sales.
Consumer products firms, such as Proctor & Gamble (P & G), use marketing information extensively in changing the nature of their products in response to consumers, including advertising, packaging, and pricing. P & G dedicates large resources to ascertaining the nature of the competition for their products and the consumer sensitivity to changes in those products. P&G works with their largest customers, including Wal*mart and Kroger’s, to know the Price Elasticity of each of the products, and when to alter pricing to manage sales levels. The information collected by the inventory management systems of the stores provides very specific price and preference information to P & G which allows the manufacturer to set prices for sales, change prices for seasonal changes in demand, and set levels of production for the planned levels of sales resulting from those pricing decisions. P & G is considered the best at brand management, and the concept of price elasticity is a fundamental measure used in their success.
Oil refining firms use Price Elasticity to set pricing on the commodities they produce. “Fuels and lubricants are known to be Price-Inelastic products, defined as commodities with limited or no substitute and low elasticity in the short-run.” When production costs increase, the firms involved in refining can be confident that a price increase will have little effect on the demand for gasoline, and therefore they can pass all of the cost increase to the consumer and expect only a positive impact on sales and revenue levels. Similarly, a reduction in production cost for the fuel products requires a commensurate reduction in price, because the availability of a substitute from another producer faced with the same costs is available. Refiners and fuel retailers are great examples of firms that use their knowledge of the price inelasticity of their product to manage production and allow the control of revenues.
Airlines use price elasticity to determine the flexibility in pricing for certain routes, and also to determine the returns on offering flights to airports served by competitors. The fact that airlines are acutely aware of the minimum passenger levels for each route to be profitable, indicates they use price elasticity in setting ticket prices based on the variable presented by each route they serve. Airlines offering flights between hubs have a cost advantage which allows them to lower the ticket price to increase passengers, knowing the passenger will select the lowest price, keeping all other considerations equal. Similarly, airlines that know they are the only flight to a particular location can use a less elastic demand in setting higher pricing to ensure costs are consistently covered. Low-fare airlines use their knowledge of price elasticity to set lower fares at levels where consumers will be willing to give up amenities or convenience for savings in travel. In the volatile and competitive business of air travel, the firms use price elasticity concepts to manage fares and predict passenger levels.
Fashion retailers use Price Elasticity to manage inventories and directly control sales and revenue levels. The stores are able to manipulate sales levels based on seasonal preferences for clothing and the sensitivity of consumers to pricing. This knowledge of consumer preference can enable a retailer to control revenue. When retailers are faced with pressure from investors, they can increase revenue by offering promotional sales; they can also maintain full pricing on items they know to be in high demand. Similarly, when new seasonal clothing arrives to the retailer, the store can reduce prices on existing stock to encourage demand and rapidly increase sales. Retailers also used principles of Price Elasticity in establishing outlet stores, knowing the small reduction in pricing and retail environment would alter demand and increase sales for certain high-end brands. Retail fashion is an industry where the concept of price elasticity is a fundamental tool in managing sales and revenues.
At all levels of Government, managers can use Price Elasticity to make decisions in determining changes in regulations, taxes, and expenditures. The Federal Departments of Commerce, Agriculture, Energy, and Treasury all spend resources collecting information specific to market demand and price elasticity. The data obtained from these sources, as well as information generated by the academic and commercial sources are used by the Government at all levels to make decisions using the concepts of Price Elasticity.
The setting of taxation levels requires an understanding of price elasticity to determine the correct level of taxation for the desired level of revenue. The alteration of the capital gains tax required knowledge of the concept of price elasticity to balance the impact of lowering the tax on investment with the potential change in the level of revenue collected from the tax. Some economists believed that lowering the rate of taxation on gains would encourage more investment, and therefore more gains, and consequently increased revenue. Other economists believed that a lower capital gains tax, although it would encourage more investment, would not necessarily increase gains. If gains from investment remained the same or reduced, the revenue from the tax would decrease. When the capital gains tax was reduced in 2003, the net effect was an increase in revenue from the lower tax rate. In all cases, tax changes are vetted against the revenue consequence of the change, which is in essence an analysis of the elasticity of that tax.
Government uses Price Elasticity as a consideration for the regulation and taxation of certain industries or products. The electric utility industry is regulated to control rate increases because the nature of the demand for electricity is highly inelastic, and a monopolistic electrical supplier could manipulate pricing knowing demand was unable to change in response. State and Federal governments have historically chosen inelastic products to impose taxes upon, such as fuel, cigarettes, and alcohol; principally to maintain a steady revenue flow from products with consistent demand, as well as selecting products whose demand is not easily influenced by price or other external economic factors.
The US Postal Service uses the concept of Price Elasticity to determine the fees it will charge for services and the types of services it will offer to the shipping customer. In considering the price of a first-class postage stamp, the US Postal Service must know the Price Elasticity of postal customers for this service. The price of a first class mailing must be low enough to compete with substitutes such as email or online communications, but must be sufficiently high to counter the costs and maintain revenue levels. Similarly, the US Postal Service must use Price Elasticity to consider what services to offer when competitor substitutes are both available and comparable in price and quality.
Price Elasticity can be also be used by Government in the use of taxes or tax incentives on elastic products to impact demand. This provides opportunity for policy to be enforced using market mechanisms instead of strict regulation. In providing a tax credit for the conversion of personal vehicles to compressed natural gas, many states are using the tax credit to counter the price inelasticity of gasoline by providing a means to create a product substitute (in using natural gas) and as a consequence, forward the policy of reducing the use of higher-polluting motor fuels. In these circumstances, the Government uses the concept of price elasticity to manipulate consumer demand in a direction that current policies might require.
The principles of Price Elasticity are used by commercial firms such as consumer products, refineries, airlines, and fashion retailers. The concept of Price Elasticity is also used in managing government as well for issues such as taxation, regulation, and the setting of fees. In general, the concept of Price Elasticity is a central tenant of understanding the pricing and demand for products and services, and is applicable to almost any industry.
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