Elasticity on Demand, Breakeven Analysis and Pricing Decisions Essay Example for Free

Elasticity on Demand, Break correct Analysis and Pricing Decisions tryWhen a firm changes hurts, the effect on winnings is more important than the effect on r flatue. thither is a simple ruler to calculate the critical Price Elasticity of demand which is just qualified to maintain the contri saveion to overheads and profits. This will be greater than that required to maintain revenue. A common eject in business and in business studies is whether a firm should change the scathes at which products are offered. The calculations come out with estimates of the reaction of customers to the new prices. This reaction is represented as Price Elasticity of Demand (PED), the ratio of the proportionate changes in volume and price. Students are always told and some students even remember that Elastic Demand (PED gt1) meaning more revenue from a lower price and less from a higher one and dead Demand (PED But who wants the same revenue with lower profits? Any change in price will ha ve a much bigger impact, proportionately, on the contribution per item for the firm than on the asking price to the customer.It follows that an increase in price may succeed in raising profits, even though revenue falls and that a lower price may reduce profits even though revenue increases. So the critical question is not whether the PED is greater or less than one, but whether it is sufficiently high (for a lower price) or sufficiently low (for a price increase) to remediate profits. The critical train of PED can be found by an application of breakeven analysis.We can take the veritable level of contribution to overheads and profit and ask what the volume (units sold) must be to pull up stakes the same level of contribution at the alternative price. Having found this critical volume, we can then compute what the PED would be to give us this volume at the new price, compared with the existing price and beat. This then will be the overcritical Price Elasticity of Demand (CPED) . If we are raising prices, any PED less than CPED will increase profits if we are lowering price, we want PED to be more than CPED.And while there is no way, short of onerous the price change, to know what the PED actually is, a firm may well have sensible ideas about the likelihood of its being significantly greater or less than a specified value. It may take care that calculating the CPED is rather a waste of time, since we should have to calculate the required change in quantity first and might just as well reckon our chances of getting this volume after our price change, without entering into Elasticity computations at all. However it turns out that there is a very simple formula for calculating the CPED.