3. Application of PED

3. Application of PED

1. Producers

   • Pricing Strategies
     • Pricing strategies refer to necessary adjustments to price in order to achieve the objectives of producer.
       • If producer aims to increase Total Revenue (TR) in hopes of maximising profit, he has to decide on price change which will achieve his aim.
         • Since TR=RxQ, whether producer should raise/lower price in order to increase TR depends on PED of good.
           • Demand price elastic - producer should lower price in order to increase TR. If demand price inelastic, producer should raise price to increase TR.
             • (EG): In a supermarket, different brans of juice are sold at substantial discounts because demand is very price elastic due to wide availability of close substitutes.
   • Marketing Strategies
     • Producers try to make demand for his good less price elastic so that he can increase TR through a price increase.
       • Degree of price elasticity is determined by availability of close substitutes.
         • The strategy to reduce the substitutability by other products ensures that consumers are less likely to switch to substitutes when the price of good increases.
           • Producers can create real or perceived differences between his products and the substitutes by introducing different features in his products or undertaking advertising.
   • Timing of decisions on pricing/marketing
     • PED increases with time, hence producers should have different strategies for different time periods.
       • In short run: Demand is relatively more price inelastic -- Producers can increase prices to increase TR.
         • (EG) Pricing of latest gadgets such as newest model of iPhones tend to be higher in short run.
         • in Long run: Demand relatively more price elastic -- Producers decreases prices to increase TR.
           • (EG) Electronic products such as TVs and Cameras tend to fall in the long run in face of increased competition.
           • However in long run, producers may not need to reduce price if they are able to differentiate their products through product innovation, marketing and fostering brand loyalty.

2. Government

   • Raise Government Revenue through taxation
     • Total Tax revenue = Tax/Unit X Quantity traded
       • Indirect taxes increases COP of producers -- supply curve shift left -- Increase in equilibrium price -- fall in equilibrium quantity.
         • Govt impose indirect tax with price elastic demand on product -- likely tax revenue increases significantly -- Because tax causes increase in price and a less than proportionate fall in quantity demanded.
           • Govt impose indirect tax with price inelastic demand on product -- tax revenue UNLIKELY to increase significantly -- Because tax causes increase in price and a more than proportionate fall in quantity demanded.
   • Discourage consumption of certain goods
     • Indirect tax increases equilibrium prices and reduces equilibrium quantity.
       • If indirect tax imposed on product with price inelastic demand, unlikely to reduce consumption significantly (Equilibrium qty)
         • Goods of price inelastic demand -- increase price -- less than proportionate fall in quantity demanded - EQ fell from Q0 to Q2
           • Imposing indirect tax on price elastic demand leads to increase in price and more than proportionate fall in qty demanded (Equilibrium qty fell Q0 to Q1). Consumption thus reduced more significantly when demand is more price inelastic.
             • THUS, govt's aim to discourage consumption of a given good, taxation will work better on goods with price elastic demand.
               • Conclusion: Indirect taxes imposed of price inelastic demand goods (cigarettes, liquor) - reduction in qty demanded will be proportionally less than increase in price. Hence, tax revenue collected would be higher but policy less effective. Thus, impt for policy makers to tailor policies wit reference to price elasticity of demand of good to achieve desired goal.
   • Redistribute income and help certain groups

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