How useful is the Concept of Demand Curve and Elasticity in forecasting sales and setting up prices?
...d to see how responsive is the quantity when any other variable changes. It is a mathematical method of calculating the responsiveness of a demand with change to any given variable. The given variable could be income, price, price of a substitute etc. The formulae to calculate price elasticity is: % change in qty demanded / % change in other variable. Elasticity can be of different measures and degrees. There are 3 main measures of elasticity. • Unitary Elastic: unitary elasticity will give us 1 as the answer to our calculation. Which means that the %change in demand will be equal to the % change in price (price-elasticity). So changing price would have equal effect on the quantity demanded. • Elastic (more than unitary elastic): this measure means that % change in price would have more effect on %change in quantity demanded. E.g. 1% change in price causes 2% change in demand. • Inelastic: this is opposite of elastic demand. This means that %change in price would cause less % change in quantity demanded. E.g. 2%change in price causes 1% change in quantity demanded. After understanding the Demand curve and Elasticity, now let’s see how useful these are in forecasting sales and setting prices. Demand curve –Forecasting sales – Setting prices: Demand curve is a very useful method of forecasting sales. If we know that at a given price say £10 we the demand will be 500units, it becomes very easy to calculate or forecast sales. The sales will be £5000. Similarly we can set prices as well based on the demand curve, if we know we want to sell more than 500 units we bring our prices down, or increase it if we want to sell less. But in the above graph we know how the demand is. The question asks ‘how useful is the concept of demand curve ‘given the demand identification problem’. If we can not identify the correct demand is it possible at all to forecast sales based on the demand curve? If draw another graph next to the original one but without the demand lets see how useful it seems in order to forecast demand or setting up prices. The second Graph does not seem to be very helpful. The reason being we do can not identify the demand and thus can not plot a demand curve. This means we can not forecast the sales or set prices if we do not know the demand. Elasticity – forecasting Sales – Setting Prices As explained above Elasticity shows the responsiveness of change in customers’ demand due to a change in any other variable. Again a very useful tool to forecast Sales and setting up prices. If we know that a product has 2% price-elasticity of demand, which means any 1 unit change in price will have double the effect on quantity demanded. Based on this equation a company can forecast what will happen to over-all sales if prices are changed by 1unit. Similarly we can also set prices based on the elasticity. In fact Elasticity is one of the most important tools when it comes to setting prices. If we know the elasticity of a demand we can set prices according to it. A highly elastic demand curve means that any change in a variable will cause a bigger change in the quantity demanded and inelastic demand curve will mean th...