1.2.3 , 1.2.5 - Elasticities Limitations for Business Decision Making

Question 1

Name the Elasticities with Business Significance

Answer 1

. All of them has some usefulness to Business

. PED, YED, XED, PES

Question 2

Name three three Criticisms / Disadvantages/ Limitations of Elasticities for Business Decision Making

Answer 2

. Elasticity calculations are only estimates

. Assumption of Ceteris Paribus can be misleading

. Elasticity varies along the demand curve

Question 3

Explain ‘Elasticities are only estimates’.

Answer 3

. Elasticities are only estimates. This is as:

. Data may have been collected from surveys, where cannot be fully trusted

. Data collected may be outdated, which will not reflect current consumer habits.

. Elasticity data is very price sensitive and changes over time

. Therefore, businesses making pricing decisions on stock, pricing, output and employment solely on elasticity is dangerous. Elasticity data must be used alongside other data sources when making business decisions

Question 4

Explain ‘ Assumption of Ceteris Paribus may can be misleading’

Answer 4

. All Elasticities assume Ceteris Paribus.

. Assumption of Ceteris Paribus can be misleading.

. This is as only one variable is assumed to impact quantity demanded or quantity supplied when in reality there are many other factors that can affect demand and supply, which a business MUST take into account when making business decisions

. For example, it is too simplistic to recommend that businesses should raise its price due to price inelastic demand of a good.

. Factors such as income, price of substitutes, change in fashion and interest rates could well offset this impact, leading to a decrease in demand

Question 5

Explain ‘Elasticity varies along the demand curve’

Answer 5

. Businesses must be careful not to generalise elasticity values to all changes in price

. This is as elasticity varies along the demand curve

. For example, using the PED figures generated when price increases from £100 to £110 (10% increase) to estimate the demand response with 10% increase in price from £110 to £121 is fraught with danger and likely to to provide inaccurate responses.

. Therefore, businesses must be sure to calculate PED calculations for ALL CHANGES in price to get a more accurate reflection of the likely demand response given that elasticity varies along the demand curve

• IN TEST DRAW PED CURVE VARIES ALONG DEMAND CURVE (Refer to Diagram in Diagram Booklet)