of

UNIVERSITY
TECHNOLOGY
MAURITIUS
By
RAMCHURRUN Neville (101612)
MBAG10!T A"#
20 September 2010
M$%&e' of B"%i(e%% A)*i(i%&'$&io( Ge(e'$l !$'& Ti*e
ECONOMICS FOR MANAGERS
MBA1101
Assignment 1
% DD or Q P , where
% Price q p
Assuming you are the business manager of a firm which sells its commodity both locally
and abroad. Explain how you can make use of elasticity concepts of demand to help you
increase your profitability over turnover of you business. Where necessary support your
explanation with relevant examples.
The elasticity concept of eman !DD" meas#res the responsi$eness of q#antity
emane to a chan%e in price& 't is an inication of the ma%nit#e of the chan%e, i&e& by how
m#ch eman is chan%in%& 't is th#s calc#late #sin% the followin% form#la(
Price )lasticity of eman !P&)&D" *
'n response to a chan%e in price, eman may be elastic !)lasticity of DD + 1", inelastic
!)lasticity of DD , 1", perfectly elastic !)lasticity of DD * -", perfectly inelastic !)lasticity of
DD * 0" an #nitary !)lasticity of DD * 1"& .lto%ether they are /nown as the DD elasticity&
This can better be represente in a schematic way as follows(
Q * 0han%e in q#antity DD
q * 1ri%inal q#antity DD
P * 0han%e in price
P * 1ri%inal price
Demand Elasticity: Downward sloping DD curve
Price
)lasticity of DD !)D" * - !perfectly elastic DD"
)D + 1 !elastic DD"
)D , 1 !inelastic DD"
)D * 1 !#nitary elastic DD"
)D * 0 !perfectly
inelastic DD"
Downwar
slopin%
2i3point
0 Q#antity Demane
The abo$e c#r$e shows ifferent elasticity conition on a eman c#r$e& .t the mi3
point is the #nitary elastic DD !)D * 1" conition an abo$e the mi3point epicts that DD in
elastic !)D + 1" whereas below the mi3point is the inelastic eman !)D , 1" conition&
4inally, on the 53a6is !)D * 0" is the perfectly inelastic DD an on 73a6is !)D * -" is the
perfectly elastic DD&
The elasticity concepts of eman are hi%hly #sef#l for a b#siness mana%er for impro$in%
the profitability sit#ation of his firm& 8ith s#ch notion the b#siness mana%er can then ecie
whether to p#rs#e a hi%h price or a low price strate%y when sellin% commoity both locally an
abroa& The followin% schema pro$ies a better o$er$iew of the perception of a b#siness
mana%er ealin% with the sale of pro#ct locally an abroa(
The abo$e ill#stration relates that a b#siness mana%er will normally aim at ma6imi9in%
his firm:s profit& Profit refers to the ifference between Total ;e$en#e !T&; * Price 6 Q#antity"
an Total 0osts !T&0 * Total 4i6e 0ost < Total =ariable 0ost" th#s, Profit * Total ;e$en#e >
Total 0osts !? * T&; > T&0" as bein% shown abo$e& .s s#ch, profitability refers to the contin#o#s
increase in profit o$er t#rno$er !e&%& @ross Profit 2ar%in an Aet Profit 2ar%in" of a b#siness
o$er a perio of time& The b#siness mana%er can achie$e this either by increasin% Total ;e$en#e
or ecreasin% Total 0osts& The Total cost can be re#ce thro#%h the implementation of latest
technolo%yB by mer%in% with another firm or thro#%h internal economies of scale& 1n the other
han, the total re$en#e can be increase by re#cin% or increasin% price& The b#siness mana%er
can %et the notion that not #ner all circ#mstances that price can be increase or ecrease to
raise Total ;e$en#e& .s a matter of fact, it all epens on the concept of Price elasticity of DD
!ncome elasticity of DD "ross elasticity of DD an Advertising elasticity of DD which can
etermine which %oos are price elastic an which are price inelastic alon% with their respecti$e
effects on DD&
Price Elasticity of DD
Profit #aximi$ation
!Profit * Total ;e$en#e > Total 0ost"
? * T&; > T&0
1& Total ;e$en#e !T&; * Price 6 Q#antity"
!a" Price DD inelastic > DD !small amo#nt"
!b" Price DD elastic > DD !lar%e amo#nt"
2& Total 0ost
!a" 2er%er
!b" Technolo%y !)conomies of scale"
. wise b#siness mana%er will always p#rs#e a low price strate%y when the eman for
his commoity is elastic& This is so beca#se a small re#ction in price always res#lts in a more
than proportionate increase in q#antity emane& 4or instance, if price increases by C%
q#antity emane ecreases by more than C%& Dere, the coefficient of elasticity is %reater than
1 an eman c#r$e has a flat shape& This can ia%rammatically be shown as follows(
4rom the abo$e elastic eman c#r$e, the initial price is S10 an q#antity DD is 100
#nits& 'f the mana%er increases the price to E11, q#antity ecreases more than proportionately to
20 #nits& The implication is that if he increases the price by 10%, q#antity emane ecreases
by F0%, which is e$iently more than 10%& 1n the other han, if price ecreases to EG, it can be
note that q#antity emane increases to 1F0 #nits& This is a%ain more than proportionate
which leas to F0% increase as a res#lt of only 10% ecrease in price& These chan%es in price
will ob$io#sly ha$e impacts on the total re$en#e of the firm an to ientify their effects, the total
re$en#e nee to be calc#late at ifferent price le$el(
The concl#sion that can be rawn from these fi%#res is that when DD is elastic, it is
a$isable for a b#siness mana%er to re#ce price as this will lea to an o$erall increase in the
Total ;e$en#e of the firm as shown in abo$e Analysis 1& 4inally, if e$erythin% remains constant,
this will lea to an increase in its profits& This will probably %i$e the mana%er the notion that
Price
0
D
D
Elastic DD: ED % &
% Qty DD + % P
Price * Total ;e$en#e
10%
10%
F0% F0%
)lastic DD > flatter
)+1
20 100 1F0
E11
E10
EG
Analysis &:
.t price E10, Total ;e$en#e * Price 6 Q#antity * 10 6 100 * E1,000
.t price E11, Total ;e$en#e * 11 6 20 * E 220 !'igh price strategy"
.t price EG, Total ;e$en#e * G 6 1F0 * E 1,H20 !(ow price )trategy"
Q#antity
!Inits"
price cannot be increase #ner an elastic eman as c#stomers are $ery sensiti$e to price
chan%es namely beca#se of many competitors on the mar/et&
4#rthermore, it wo#l be a$isable for the mana%er to p#rs#e a hi%h price strate%y when
eman for his pro#ct is price inelastic& This is beca#se the increase in price ca#se a less than
proportionate ecrease in q#antity emane& Dere, the coefficient of elasticity is less than 1 an
the DD c#r$e has a steeper shape& This can be represente an escribe as follows(
4rom the abo$e inelastic DD ia%ram, the initial price is E10 an q#antity emane is
100 #nits& 'f the mana%er increases the price to E1C, q#antity emane ecreases to only G0
#nits& The implication is that if the mana%er ecies to increase price by C0%, q#antity
emane ecreases by only 10%& 1n the other han, if price ecreases to EC it is q#ite clear
that q#antity emane increases to 110 #nits& 't can be note that q#antity emane has not
m#ch been affecte as it has relati$ely ecrease by 10% only as a res#lt of a C0% ecrease in
price& .%ain, the effects of chan%es in price relati$e to total re$en#e will be calc#late as
follows(
The concl#in% statement that the mana%er can eri$e from these res#lts is when DD is
inelastic he is a$ise to increase price beca#se Total ;e$en#e will rise& .%ain citeris paribus
!ass#min% all other thin%s remain #nchan%e", the Total ;e$en#e of the firm will increase an
this in t#rn will ca#se an increase in its profits&
!ncome elasticity of DD *+ED,
Price
0
D
D
!nelastic DD: ED - &
% Qty DD , % P
C0%
C0%
10%
10%
)lastic DD > flatter
) +1
G0 100 110
E1C
E10
EC
Q#antity
!Inits"
Analysis .:
.t price E10, Total ;e$en#e * Price 6 Q#antity * 10 6 100 * E1,000
.t price E1C, Total ;e$en#e * 1C 6 G0 * E 1,JC0 !'igh price strategy"
.t price EC, Total ;e$en#e * C 6 110 * E CC0 !(ow price )trategy"
/ 0 in 1uantity demanded of 2
/ 0 Price of A
'ncome elasticity of DD !7)D" is another #sef#l tool to the b#siness mana%er in
meas#rin% the responsi$eness of eman to a chan%e in income& . /nowle%e of the 7)D
allows for e6ample, a b#siness mana%er of a to#r or%ani9er who pro$ie facilities both locally
an abroa, to creit the li/ely pattern of f#t#re eman for tra$el as cons#mers: real income
rises& 4or instance, we ass#me that the mana%er has to ecie between increasin% the n#mber of
ay coach trips an intro#cin% a new l#6#ry to#r ser$ice& 'f mar/et research re$eals that 7)D
for ay trips is ne%ati$e, then eman will rise more proportionately o$er time than income, an
the mar/et is e6panin%& 'n aition, 7)D enables a mana%er to etermine which %oos are
normal, $erblen !l#6#ry cars, Kewelry" or %iffen !inferior %oos li/e ration rice"& 'f the mana%er
is sellin% %oos locally an abroa he will ob$io#sly ha$e reco#rse to 7)D of both co#ntries to
etermine their eman patterns& 8hen income is e6pecte to rise, the mana%er will be able to
/now that people will eman more of normal an $erblen %oos as compare to %iffen %oos&
'n this way, the mana%er can consier these patterns an ta/e the initiati$e towars ma6imi9in%
the profitability of the firm&
"ross Elasticity of DD *3ED,
0ross elasticity of DD !5)D" will enable the mana%er to meas#re the responsi$eness of
eman for one %oo to a %i$en chan%e in the price of a secon %oo, i&e& to etermine which
%oos are complements an s#bstit#tes& 'f the mana%er increases the price of his commoity
!e&%& tea", the eman for complements !e&%& mil/" will fall whereas eman for s#bstit#tes !e&%&
coffee" will rise& The 5)D $al#e will tell the mana%er which pairs of pro#cts are s#bstit#tes
!positi$e 5)D coefficient", complements !ne%ati$e 5)D coefficient" or inepenent %oos
!5)D * 0"& 'f we reconsier the same e6ample of mana%er of the to#r or%ani9er mentione
earlier, he can estimate the wier effects of isco#ntin% ne holiay& .ss#me that the 5)D
coefficient between holiays . an L is 2& The effects of a 10% re#ction in the price of holiay
. is calc#late from the eq#ation(
3ED 4
The 20% fall in the q#antity emane of L may isco#ra%e the mana%er from
isco#ntin% the price of .& 5)D also permits him to assess the effect of a loss3leaer strate%y
where the price of one %oo is hea$ily re#ce in the hope that aitional p#rchases of other
pro#ct will compensate& Moss3leaer campai%ns are most effecti$e when the 5)D of a pro#ct
with respect to a lar%e n#mber of other %oos sol by the firm is ne%ati$e an less than one& The
loss mae on one item is mae #p by the profit from the sale of complements&
Dowe$er, the elasticity concepts of eman ha$e %ot certain limitations& Price elasticity
chan%es o$er time as competition chan%es an cons#mer tastes an preferences chan%e& 0ertain
elasticity s#ch as income elasticity may $ary as pro#cts come to seem more or less of a
necessity nowaays&
)$en tho#%h elasticity can $ary o$ertime, certain feat#res ten to remain constant&
Stron% brans s#ch as Me$i:s an 0oca 0ola ha$e relati$ely low price elasticity& This %i$es them
the power o$er mar/et pricin% that enables stron% profitability year after year& 4or less
establishe firms, these brans are the role moel& )$eryone wants to be the 0oca 0ola of their
own mar/et or mar/et niche&
4inally, it can be concl#e that espite certain minor rawbac/s, the theory of eman
elasticity remains hi%hly #sef#l to a b#siness mana%er of a firm which sells its commoity
locally an abroa& De can ma/e #se of s#ch concept in se$eral ways in $iew of increasin%
profitability o$er t#rno$er of his b#siness, as f#lly escribe abo$e&