A business decides to increase the price of a product in order to improve its profit. Analyse how the success of this decision is affected by the product’s price elasticity of demand.
Whether a price increase will increase profit depends almost exclusively on price elasticity of demand. If the price of the product is inelastic, then changing the price within the boundaries of the inelasticity will not impact the demand. If this is the case, then increasing the price by the maximum allowed value by PED, the only impact would be an increased profit.
However, in most scenarios it is not this simple. Most businesses face competitors who are able to closely compete on price. In cases like these, say where the business sells apples, there are many places where a consumer can get apples, so the price must be competitive otherwise a business will not attract sales. Here, the price elasticity of demand would be elastic, because any changes in price will impact the demand.
Having a competitive price is only part of the image however, as costs are typically something a business cannot easily negotiate. Therefore, they need to consider what their minimum possible price is and then decide how much more than this they can reasonably charge in order to maximise revenue. Price elasticity of demand is always a useful tool to review when making pricing related decisions as it provides valuable insight into whether a pricing change would increase actual earnings and it reduces the risk.
Include a specific example. Include more specific values.