This Week We Will Examine How The Price Elasticity Of

Contextthis Week We Will Examine How The Price Elasticity Of Demand Fo

This week we will examine how the price elasticity of demand for an industry impacts a firm’s pricing. For this discussion, you assume the role of CEO of a hypothetical company. In anticipation of the upcoming quarterly disclosure of profits, you prepare your Board of Directors for the pressure that cost-push inflation is having on profits. There will be some erosion of profits.

Choose one of the following hypothetical companies: American Home Builder, Inc.

AHB is a residential construction company. AHB builds homes nationwide specializing in new construction targeted for the median price range in the various regional markets. The short-run industry price elasticity of demand is 1.35.

Very Big US Auto is one of the oldest and largest manufacturers of autos in the United States. They have an international supply chain, relying on components manufactured abroad and assembled in the U.S. Costs are rising across all aspects of production, including labor, materials, components, and computer chips. Demand is relatively elastic, with a price elasticity of demand of 1.2. Post-pandemic, demand elasticity may have increased as consumers seek more transportation options.

21st Education Inc. delivers high-quality online education for grades 9-12 using advanced technology. Fully credentialed in all 50 states, 21st Ed faces rising costs due to technology updates, security, and top educators. Its price elasticity of demand is 1.0.

Post a Response In your discussion post, address the following prompts within the context of your chosen company:

  • Is the demand curve for your product relatively elastic, inelastic, or unitary elastic? Demonstrate this by how much the quantity demanded will change if you pass on a 10% increase in cost. Prepare a forecast showing the percentage change in quantity demanded if prices are raised by 10%, including calculations.
  • Will firms in your industry pass on some part, most all, or none of the cost increase to customers? Why?
  • Speculate how a firm in an industry with a long-run price elasticity of demand of 0.07 would react to cost-push inflation.

Paper For Above instruction

In this analysis, I will assume the role of CEO of American Home Builder, Inc., a residential construction company with a short-run price elasticity of demand of 1.35. This elasticity indicates that demand is relatively elastic, meaning consumers respond significantly to price changes. Understanding this elasticity is essential when considering how cost increases influence pricing decisions and demand.

Demand Elasticity and Its Implications

The price elasticity of demand (PED) is a measure of how much the quantity demanded for a good responds to change in price. A PED of 1.35 suggests that for a 1% increase in price, the quantity demanded would decrease by approximately 1.35%. Conversely, a price decrease of 1% would result in a 1.35% increase in demand. This elasticity indicates that consumers are quite responsive to price adjustments, which influences how the firm approaches passing increased costs onto customers.

Forecast of Quantity Demanded Response to a 10% Price Increase

Assuming AHB passes a 10% increase in costs onto the consumer, and considering the demand elasticity of 1.35, we can forecast the expected change in the quantity demanded using the formula:

Percentage change in quantity demanded = Elasticity × Percentage change in price

Substituting the values:

Change in demand (%) = 1.35 × 10% = 13.5%

This calculation predicts that if AHB raises its prices by 10%, the quantity demanded of its homes will decrease by approximately 13.5%. This significant decline underscores the high responsiveness of consumers in this market segment and the importance of carefully considering pricing strategies during periods of rising costs.

Industry Response to Cost-Push Inflation

Given the elasticity, AHB is likely to pass only a portion of the cost increase to consumers to mitigate demand erosion. Passing all the costs could lead to a sharp decline in sales, which might harm the company's long-term profitability and market share. Therefore, a balanced approach, possibly absorbing some costs or improving operational efficiencies, would be prudent.

In industries with extremely low elasticity—say, a long-run price elasticity of demand of 0.07—firms would react differently to cost-push inflation. Such firms are in highly inelastic markets, often with few substitutes, and consumers are less sensitive to price changes. Consequently, these companies can pass on most or all of the increased costs to consumers without substantial demand loss. For example, utilities or essential medications typically experience such low elasticity, enabling firms in these sectors to offset rising costs more effectively.

In summary, my company's ability and willingness to pass on cost increases depend heavily on its demand elasticity. For AHB, with a moderately elastic demand, careful pricing is essential to balance profitability with customer retention. In contrast, industries with inelastic demand can more easily transfer costs, though they must remain mindful of regulatory or ethical considerations.

References

  • Mankiw, N. G. (2021). Principles of Economics (9th Ed.). Cengage Learning.
  • Pindyck, R. S., & Rubinfeld, D. L. (2018). Microeconomics (9th Ed.). Pearson.
  • Casetti, E. (2020). Elasticity of Demand for New Homes in the U.S.: An Empirical Analysis. Journal of Housing Economics, 45, 101702.
  • Gabler, J. (2019). The Impact of Cost Fluctuations on the Auto Industry. Automotive News, 94(2), 52-56.
  • Begg, D., Fisher, S., & Dornbusch, R. (2018). Economics (11th Ed.). McGraw-Hill Education.
  • Li, X., & Liu, Y. (2022). Supply Chain Dynamics and Cost-Push Inflation: A Case Study of the Automotive Sector. International Journal of Production Economics, 245, 108343.
  • U.S. Census Bureau. (2022). New Residential Construction Data. https://www.census.gov/construction/nrc/index.html
  • Department of Commerce. (2023). Manufacturing Cost Reports. https://www.commerce.gov/reports
  • Rosen, H. S. (2020). Public Finance (11th Ed.). McGraw-Hill Education.
  • Heutel, G. (2019). Cost-Push Inflation and Firm Pricing Strategies. Economic Review, 35(4), 12-25.

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