Price Elasticity Of Demand Of The Product example essay topic

Introduction This report has been produced to analyse the possible implications of increasing the price of our 100 Watt light bulbs by 20%. Presently the cost of a light bulb is lb 0.80. This report will aim to fully assess and evaluate the price elasticity of demand of the product, which will enable an informed decision to be made on whether a price increase will be financially viable for the company. Concept of price elasticity The concept of price elasticity of demand (PED) is to measure the responsiveness of the quantity demanded to a price increase or decrease, with all other factors remaining the same. This is achieved by comparing the percentage change of the price of a product, in relation to the percentage change in demand for that product, and is calculated as follows, PED (price elasticity of demand) = Percentage change in the quantity demanded Percentage change in the price The determining factor in the above calculation depends on whether the PED is above or below 1. The price elasticity of demand can be split into three different categories once the above calculation is completed: Price Elastic If a product is deemed to be price elastic, the calculation will reveal that the PED is greater than 1, this shows that the percentage change in quantity demanded is greater than the % change in price.

Price Inelastic If the price is inelastic, the calculation will reveal that the PED is less than 1 indicating that the percentage change in price is greater than the percentage change in quantity demanded. Unitary elasticity If the price is classed as unitary elasticity, the PED calculation will work out at exactly 1. This shows that percentage change in price is equal to the percentage change in quantity demanded. The relevance of PED to pricing decisions The price elasticity of demand is a very helpful tool in deciding how to price a product, as there is a direct link between price elasticity and revenue. If a product is price elastic it is susceptible to price change, this means that increases in price will have a negative effect on total revenue. Conversely, if the price is inelastic this indicates that there is a positive relationship between elasticity and revenue and the product is not particularly susceptible to price change, therefore if there is an increase in price there will be an increase in revenue.

It can be seen that all firms aim to achieve an inelastic price of demand, because they can then increase their prices knowing that the customers will still be willing to purchase the product. This ties in with competitive advantage, meaning that once you are a market leader you can control prices to a certain degree. Factors of demand for 100 watt light bulbs It is important to look at what factors may affect the demand for 100 Watt light bulbs. Looking firstly at price Price of our light bulbs Last year a survey was carried out to assess the sensitivity of sales to price for our 100 watt light bulbs, the results were as follows, Price Sales (Million) Revenue (Million) % Change in price % Change in Sales lb 0.80 5800 4640 25% 31.03% lb 1.00 4000 4000 If we then apply these results to the aforementioned equation for PED, PED = % Change in QD 31.03 = 1.24%Change in P 25 It can be clearly see from the calculation above that the demand for 100 Watt light bulbs is elastic, and therefore sensitive to price change. The price of other companies light bulbs Another factor in determining the demand for light bulbs may be the price of our competitor's products. We have already seen from the calculation above that the price is elastic.

If another company making light bulbs offers consumers a lower price, or a better deal i.e. a two for one offer, we may find that demand for our product falls. Consumers may be unwilling to pay more for an identical product they can find cheaper elsewhere. Availability of substitute products Availability of substitute products may also play a part in the demand for 100 watt light bulbs. It can be seen that over recent years the availability of energy saving light bulbs such as Incandescent and Halogen Light Bulbs are on the increase. These bulbs can last many times longer than a standard light bulb. Prices of these substitutes are currently high in comparison to standard 100 W bulbs but may fall as the country and government strives to become more energy efficient, this may have a direct effect on the demand for our product.

Conover (February 5, 2003) Recommendations The above graph has been plotted to assess whether there should be a rise of 20% to the price of the companies light bulbs. It can be clearly seen from the graph that an increase of 20% would add and extra lb 0.16 of revenue per bulb sold, however the price rise also causes a loss in demand from 5800 Million to 4400 Million. The table below shows the predicted subsequent effect on revenue, Price Sales (Million) Revenue (Million) % Change in price lb 0.80 5800 4640 20% lb 0.96 4400 4224 Taking into consideration the earlier finding that the price of light bulbs is elastic, meaning any price rise will reduce demand, and the findings of the graph which indicates that a 20% increase in price would result in a predicted lb 416,000 of lost revenue, it is recommended that the price should not be raised.

Bibliography

Conover, C February 5, 2003 'Light bulbs, Floodlights and Spotlights: which bulbs to use? An extremely brief and incomplete tutorial and review', Available from: web (Accessed 12/11/2003) Worthington, I.
Britton, C, 2003.