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Economics explained



Uses of price elasticity of demand

Uses of price elasticity of demand

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Helping firms to decide on their pricing strategy

A firm while fixing the price of the market has to determine whether its product is of elastic or inelastic nature.

If the product is inelastic, the producer can earn a profit by setting a high price.

If the product is elastic, the producer must set low or at least a reasonable price so that the consumers are attracted to buy the goods.

For example, fuel is a necessity for consumers. Therefore, firms that run the market of fuel can generate profit even by setting a high price for fuel. On the other hand, luxury goods have a high price elasticity of demand because they are sensitive to price changes.

Predicting the impact on firms following changes in the exchange rate

Firms that rely on exports will generally benefit from lower exchange rates (as the price of exports become cheaper) and thus will become more price competitive. This assumes that the PED for exports is elastic.

Price discrimination

This occurs when firms charge different customers different prices for essentially the same product because of differences in their PED. For example, theme parks charge adults different prices from children and they also offer discounts for families and annual pass holders.

Deciding how much of a sales tax can be passed on to customers

For example, products such as alcohol, tobacco and petrol are price inelastic in demand, so government taxes on these products can quite easily be passed on to customers without much impact on the quantity demanded.

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