Question

What is perfectly elastic all about ? explain what decision you make when your product is elastic, in terms of pricing strategy?

Answer 1

A perfectly elastic good is one whose quantity demanded changes infinitely with the slightest change in the price. If a good is elastic, the decision to be taken in terms of pricing strategy is that the price should be reduced. This is because, as the good is elastic, the proportionate increase in quantity demanded will be much greater than the proportionate decrease in price. So, the final effect will be an increase in total revenues. Lets look at an example:

Initial price: $5    Quantity demanded: 10    Total Revenue : 10 x 5 = $50

Price after Reduction : $4    Quantity demanded : 13 Total Revenue : 13 x 4 = $52

So, a 20% fall in price led by a 30% increase leads to a 4% increase in total revenues. So, this kind of strategy in case of elastic demand leads to higher total revenues.