Question 1

The price elasticity of demand (PED) is a measure that captures the responsiveness of a
good’s quantity demanded to a change in its price. More specifically, it is the percentage
change in quantity demanded in response to a one percent change in price when all other
determinants of demand are held constant. This definition implies that there are other factors
which affect the responsiveness of demand toward a price change and these are called
determinants.

Price is not always the driving factor for sensitivity, in some scenarios, for example a price
for a restaurant meal may go up and yet demand stays constant or even goes higher. This can
only be possible if there are other overriding factors.

These factors influence the elasticity of demand apart from a change in price. With regards to
restaurant meals not only prices affect the demand for the meals. There are other factors
single or combined which affect the movement of demand when prices of meals go up or
down. The basic law of demand states that when the price of a product is increased, the
demand will decrease and vice versa, however this is not always the case due to other factors
which come into play. For restaurant meals the following determinants affect price
sensitivities.

When an individual's income rises, they can buy more expensive products or purchase the
products they usually buy in a greater volume. As a result, this causes an increase in demand.
Conversely, if incomes drop, then demand is likely to decrease. Usually, this trend will
acutely affect ‘luxury’ markets, such as vacations, cars, or restaurants. Furthermore, products
that suffer a fall in demand while incomes rise are referred to as ‘inferior goods’. If many
consumers begin to lose their source of income, or have it lowered, then luxury spending
such as restaurant dining will decrease and, as stated before, an increase in cheap dining.

Demand the availability of the number and kinds of substitutes for a commodity is also
significant in determining price elasticity of demand. If for a commodity close substitutes are
available, its demand tends to be elastic. If the price of such a commodity goes up, the people
will shift to its close substitutes and as a result the demand for that commodity will greatly
decline. The greater the possibility of substitution, the greater the price elasticity of demand
for it. If for a commodity substitutes are not available, people will have to buy it even when
its price rises, and therefore its demand would tend to be inelastic. In the context of restaurant
meals, consumers will opt to cook at home than spend on restaurant foods, which literally
means PED for restaurants foods becomes highly elastic that is the higher the price of
restaurant foods the less demand for such foods.

Degree of necessity: If a good is a necessity, then the demand tends to be inelastic. For
example, if the price for drinking water rises, then there is unlikely to be a huge drop in the
quantity demanded since drinking water is a necessity. With regards to restaurant foods, as
eluded earlier, in a recession they become luxuries and are not ranked as necessities in life
and as such PED will be elastic. However, other variables such as locality also come into
play. For a tourist resort destination for example Durham “America's Foodiest Small Town”
where restaurant business is the core business then PED may become inelastic given that
demand for restaurant foods in such locations is always high given the fact that people visit
such places to spend money on food.
Proportion of the purchaser’s budget consumed by the item: Products that consume a large
portion of the purchaser’s budget tend to have greater elasticity. The relative high cost of
such goods will cause consumers to pay attention to the purchase and seek substitutes. In
contrast, demand will tend to be inelastic when a good represents only a negligible portion of
the budget. The more restaurant meals consume one’s greater part of the budget the more one
seeks for alternatives thereby affecting demand.

Nature of Commodity: The elasticity of demand also depends on the nature of the
commodity. The product can be categorized as luxury, convenience, necessary goods. The
demand for the necessities of life, such as food and clothing is inelastic as their demand
cannot be postponed. The demand for the Comfort Goods is neither elastic nor inelastic. As
with the rise and fall in their prices, the demand decreases or increases moderately. Whereas
foods and clothing are the items where an individual spends a major proportion of his income
and therefore, if there is any change in the price of these items, the demand will get affected.

Brand loyalty: An attachment to a certain brand (either out of tradition or because of

proprietary barriers) can override sensitivity to price changes, resulting in more inelastic
demand.

Question 2: usefulness of elasticity concepts in making decisions

The usefulness of the concepts of elasticity to a tourist resort can be discussed in terms of how they
can aid the firm in making pricing and capacity decisions thereby increasing productivity and making
the business more profitable.

Price elasticity of demand is defined as an economic measure of the change in the quantity
demanded or purchased of a product in relation to its price change. Price elasticity of demand
can be a useful tool for businessmen to make crucial decisions like deciding the price of
goods and services. The primary objective of any tourist resort is to earn profit or increase
revenue. Therefore, increasing price of its products to maximize profit is one of the primary
concerns of producers.

However, during the course of increasing price, the managers must not forget that demand
and price share an inverse relationship. They must be aware that demand falls with rise in
price. And thus, they must increase price of their commodity to that level where their desired
or optimal profit is still achievable without compromising customer loyalty and customer
base.

Price elasticity of demand concept is not all about price increase against demand, one has to
analyse the effects of also lowering prices. In tourist resort one should consider whether lowering
of price will lead to an increase in the demand for tourist services, and if so, to what extent and
whether his profits would increase as a result thereof. Here the concept of elasticity of demand
becomes crucial.

Sound knowledge of the nature of the elasticity of demand for a tourist resort will help a manager to
decide whether they should cut their price in a particular case. Such knowledge would also help one
to determine whether and to what extent the increase in costs could be passed on to the consumer.
In general for services those whose demand is elastic it will pay to charge relatively low prices, while
on those whose demand is inelastic, it would be better off with a higher price. A monopolist would
not be able to increase his price if the demand for his product is elastic.

The elasticity of demand is the basis of demand forecasting. The knowledge of income elasticity is
essential for demand forecasting of producible goods in future. Long- term production planning and
management depend more on the income elasticity because management can know the effect of
changing income levels on the demand for his product.

Haines, Leslie. "Elasticity is Back" Oil and Gas Investor. November 2005.

Hodrick, Laurie Simon. "Does Price Elasticity Affect Corporate Financial Decisions?"
Journal of Financial Economics. May 1999.

Montgomery, Alan L., and Peter E. Rossi. "Estimating Price Elasticity with Theory-Based
Priors." Journal of Marketing Research. November 1999.

Perreault, William E. Jr., and E. Jerome McCarthy. Basic Marketing: A Global-Managerial

Approach. McGraw-Hill, 1997.