ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

PRODUCER PRICING POLICY: AN APPLICATION OF PRICE ELASTICITY OF DEMAND

Updated on March 4, 2011

In pricing its products, the firm, supplier or producer ought to know the price elasticity of demand for the products. This is important because whether revenue can be increased or not depends on knowledge about how to apply the concept of price elasticity of demand in this regard. When the price of a product is increased or decreased, the revenue (total revenue) also changes except where the demand is unit elastic. Demand is unit elastic when a percentage change in price results in the same percentage change in quantity demanded. As to whether the revenue will increase or decrease when price is adjusted, depends on the price elasticity of demand for the product. Revenue refers to the total amount of money that a firm receives from the sale of its output. Revenue = price × quantity demanded /sold.

When the price of a product is increased, the total revenue derived from the sale of the commodity, will increase, if the demand for that product is inelastic. This is because the increase in price of the product by the seller (for whatever reason) results in a less than percentage decrease in quantity demanded. In other words, since the demand is inelastic, the decrease in the buyer’s quantity purchased as a result of increase in price, is not large enough, compared to the increase in the price. For the fact that we multiply price by quantity to get revenue, it means, for inelastic demand, increase in price will lead to increase in revenue. For this reason, for a product that has inelastic demand, the firm, producer or supplier must increase price in order to increase revenue. How do we know whether the demand for a commodity is elastic or inelastic? As a seller you might have data on the various prices of your product and the sales (quantity demanded) at the various prices. With this is at our disposal, we can use the formula for calculating price elasticity to know the elasticity status, which then informs us as to whether one must increase price or decrease price in order to increase revenue.

Assuming the price of a product, say product A is initially $100 and the quantity demanded at that price is 20. Price of good A increases to $150 and quantity demanded falls to 18. In this case the demand is inelastic (percentage change in quantity is less than percentage change in price). Revenue at the initial price is $100 × 20 = $2000. At the new price of $150, revenue = $150 × 18 = $2700. Clearly, revenue after the increase in price of good A exceeds revenue before the increase in its price. Thus for a commodity with inelastic demand, we increase its price in order to increase total revenue. On the other hand, a reduction in price of a product with inelastic demand will result in decrease in total revenue.

If price of commodity A were to increase initially from $100 to $120 and the corresponding quantity demanded fall from 50 to 30, then an estimate of the price elasticity will indicate that demand is elastic for good A. Total revenue at price $100 is $100 × 50 = $5000. However, at the higher price of $120 it is $120 × 30 = $3600. Revenue in this case is less than what it was before the price increase. Since revenue before the increase in price is more than after the price increase, and knowing that the demand is elastic, it stands to reason that for a product with elastic demand, price ought to be reduced for the seller to increase revenue.

For unit elastic demand, a change in price of the product results in the same percentage change in quantity demanded. If for example price of a product falls from $51 to $50 (2% fall in price) and its quantity increases from 100 to 102 (2%) increase in quantity demanded, then total revenue at $51 is $51 × 100 = $5100. The revenue at price $50 is also $50 × 102 = $5100. Total revenue at both the high price and low price is the same i.e. $5100. For unitary elastic demand therefore, an adjustment in price as an attempt to increase revenue will not yield any results. In fact, any percentage change in price will induce the same percentage change in quantity demanded. Total revenue will not be affected. Producers of a commodity that may have such elasticity will need to produce more and sell more in order to increase revenue rather than changing price.

The concept of price elasticity aids governments to know the effect of certain policy decision on prices and their effect on total revenue of producers. If for example the government wants to encourage the consumption of locally produced goods, by reducing its price, the knowledge of price elasticity of demand for the commodity will guide the government. If the demand is inelastic the reduction in price will lead to a fall in total revenue and factors of production employed in that industry may be reduced. On the other hand, if the demand is elastic, this will lead to an increase in total revenue of producers and may even result in employment of factors of production in that industry.

Comments

    0 of 8192 characters used
    Post Comment

    No comments yet.

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: "https://hubpages.com/privacy-policy#gdpr"

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)