IB Micro Economics, PED (price elasticity of demand) and Firms

[luckyscar]

Homework Statement

What is it: Practice Paper 1 b question for SL Economics IB

Question: Discuss why it may be important for a firm to have a knowledge of price elasticity of demand.

PS: It isn't stated explicitly to use a diagram, but my understanding is all Paper 1 questions need to be answered with diagrams to receive full points.

Homework Equations

NA as far as I understand it. I don't think any equations are needed.

The Attempt at a Solution

I was taught way back to use DEDE to answer everything. I always struggle with second d, diagram. (doing retakes, teaching was a while ago)

Define: Price Elasticity of demand - Price elasticity of demand is a measure of how much the quantity demanded of a product changes when there is a change in the price of the product.

Evaluate: PED is important for a firm to have knowledge on because it can help them to maximize profit and minimize lost profits due to the concepts important to PED. If a product has a higher price, it tends to have a more elastic demand because consumers are more concerned when the price of an expensive product rises than they are when the price of an inexpensive product rises. This concept helps a firm know the risks and advantages of changing a products price. Simultaneously, the relationship between price and demand is almost directly related to a firm's potential revenue. They want to find the optimal price so that the price * the quantity sold equals as high a number as it can. If a product has inelastic price elasticity, such as cigarettes, the firm can charge a higher price, without losing a huge amount of demand and potentially earning more money. On the other hand, a product such as a particular brand of bottled water, has a elastic price elasticity as a result of the high amount competition and tiny amount of variability in quality. So, in the case of the water bottle, a firm would be unable to realistically set a high price and make more money, for demand would go down too low.

My issue here is simply with the diagram and uncertainty on how much I need to cover in my answer. I assume I need to use a supply/demand curve, but what should I show on it? Just the shift in Q demanded in relationship to a change in price with the bottled water vs cigarettes? Would that be enough?

(I'm bad at drawing diagrams, I'd appreciate it if someone would draw an example of what I need, though that isn't 100% necessary.)

 

[phinds]

I can't help you much but I would caution you about the following statement:

... If a product has a higher price, it tends to have a more elastic demand because consumers are more concerned when the price of an expensive product rises than they are when the price of an inexpensive product rises.

While it's true that it TENDS that way, you can't overlook things like a very high cost AIDS drug. The demand is quite rigid ... get the drug or die.

Also with high end "obvious consumption" items, exclusivity can increase demand as prices go up which is of course the opposite of normal PED