Question

Question 1: If a firm knows that they face a highly elastic demand curve, does this mean that it is necessarily a good business decision to lower prices?

Question 2: Give an example of an inferior good. Do companies that produce inferior good tend to perform better or worse during economics downturns? Explain why.

Answer 1

(Question 1)

When demand is highly elastic, a given increase (decrease) in price decreases (increases) quantity demanded more-than proportionately, therefore total revenue decreases (increases). Therefore, as long as the cost structure remains unchanged, lowering price is a good decision because, higher total revenue will lead to higher profit.

(Question 2)

An inferior good is a good whose demand increases (decreases) with a decrease (increase) in consumer income. For example, bus ride is an inferior good. When consumer income is low, demand for bus rides rises and when income is high, demand for bus ries falls as consumers shift to car or other private transportation modes. Therefore, companies selling inferior goods perform better during economic downturns since demand for their goods rises during a period of lower income.