why is price elasticity of demand important to a business
Price elasticity of demand affects a business's ability to increase the price of a product. Elastic goods are more sensitive to increases in price, while inelastic goods are less sensitive. Assuming that there are no costs in producing the product, businesses would simply increase the price of a product until demand falls. Things become more complicated, however, after introducing costs.
Let's say that the cost of vanilla flavoring increases as a result of short market supply. As profits equal revenue minus costs, this would lower the ice cream shop's profits. If costs were close to the price of vanilla ice cream, profits would be almost zero. As vanilla ice cream is elastic, the shop manager would be unable to increase the price without damaging demand.
Some businesses, therefore, sell some goods that have little to no profit margin. Their main profits come from products in higher demand. In this case, the ice cream shop would increase the price of the more inelastic good, chocolate ice cream, in order to compensate for the loss in profits.
In some industries, demand for goods varies greatly during the year.
For example, demand for ice creams sold from vans is usually high during the summer and low during the winter. This will usually mean that sellers can command higher prices during the summer. From the other perspective, supply can also vary seasonally. For example, some types of fish may be harder to catch during the winter, raising the price a restaurant has to pay for them.
This can create an interesting effect as demand among customers for fish dishes may not be seasonal. This means restaurants may find it difficult to raise prices for these dishes in the winter, leaving them to choose between taking a lower profit margin and only offering the dishes at certain times of year.
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