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An overview on Elasticity of Demand and some other Economic Definitions

Trần Thị Thuỳ Dung

Columbia Southern University

ACC 6053_Economics for Managers_Unit II Essay

Dr. Seifu Zerihun

Due date: February 28th, 2021

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Introduction

Buying and selling as well as exchanging goods in general is indispensable commercial

activities since ancient times. Today, from the point of view of economics, many concepts as

well as analysis are given, to bring people involved in commercial activities to understand the

advantages and disadvantages of the activities they are participating in. From there, chanages in

strategies are given to improving competitiveness as well as business efficiency. This article

focuses on demand elasticity, as well as other definitions like opportunity cost, sunk cost to

examine how they affects the decision-making in trading. Also, two ethical theories mentioned

are Deontology and Consequentialism.

Part 1 Demand elasticity

The demand elasticity of the demand for a good by a certain variable (price, income ...)

represents the degree of change in the quantity demanded for this good in response to a certain

level of change the aforementioned number, in terms of other factors is constant. It is often

referred to as price elasticity of demand, income elasticity of demand and cross-price elasticity of

demand.

In the scope of this essay, the price elasticity of demand will be focused mainly. It is

measured as the ratio of the percentage change in quantity demanded to the percentage change in

price level. We can canculate the price elasticity of demand as below:

QD: the quantity demanded

P: the price of good

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QD: change in quantity demanded; P: change in price

Since the quantity demanded and the price level of a good tend to move in opposite

directions, the elasticity of demand is usually negative. It tells us how by 1% when the price of

the good goes up (or down) the quantity demanded for the good decreases (or increases) by how

much. For example, when eP = -2, that means, if the price of a good goes up 1%, the quantity

demanded for the good decreased 2%.

Let’s have a look at the statistics from The United States Department of Agriculture

website to examine elasticity of demand of two different commodities: bread and beer.
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Oviously we can see bread is necessary for life while beer is not. That’s why there is

difference in elasticity of demand. And then, there are goods with elastic demand and goods with

inelastic demand, too.

Goods with elastic demand will change the quantity demanded if there is change in price.

People will reduce their consumption of that kind of goods if the price increased. This means
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without the goods, people can still continue their life. Most of the unnecessary goods have elastic

demand, such as cosmetics, snacks, perfume, decorative items, accessories, alcohol,…

Goods with inelastic demand will not change the quantity demanded if there is change in

price. Without that kind of goods, people cannot servive, therefore, they need to spend for the

goods regarless how much change in price. We can consider all of necessarities are goods with

inelastic demand, such as food, water, medicines, vaccine, fuel, …

Part 2 Marginal Analysis

In economics, marginal analysis is the process of calculating and estimating whether the

benefits will increase when a company or firm invests an additional amount of value (money) or

an input unit in the production process.

The simplest thing is, normally company ABC produce 100 products with 350 USD for

total cost (200 USD for fixed costs and 1500 USD for variable costs), and ABC sells each

product with the price of 25 USD. This means each product bring a profit of 8 USD. If company

ABC decide to produce more products in case the fixed costs stay the same bacause they don’t

have to buy more machine, they just have to invest an additional amount of variable cost which

costs them 15USD/product. This means with one more product sell, ABC get 10 USD profit. In

this case, ABC should expand their production this way.

Therefore, the method of marginal analysis is quite important for the manufacturer in

decision making.

● Definition: Marginal cost (MC) is the additional cost to make and sell one additional

unit of output (Q)

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● Definition: Marginal revenue (MR) is the additional revenue gained from producing

and selling one more unit.

From this, the company should compare MC to MR before making any decision. In case

MR>MC, company should invest to produce and sell more products. But in case MR<MC,

company should reduce the production, there is no more investment that is necessary in this case.

To do this, the company should determine the exact marginal cost, by recognizing the

sinking cost, and avoid confusing it with other costs.

Sunk costs are costs that have arisen before, cannot be changed and they always exist

under any plan that the company is about to come up. Therefore, it is impossible to let it change

the company's business decision.

Avoiding sunk costs is one of the most important tasks. Avoiding sunk costs, in my

opinion, is to avoid arising, and when unfortunately incurred, avoid calculating the general costs.

Avoiding sunk cost will help the company avoid financial loss. Products manufactured under

good cost control will not incur any unreasonable costs. Consumers who pay for a product at a

reasonable price will always support the company's product. In addition to that, the elimination

of useless costs will also reduce the cost burden for the company, reasonable product prices,

bring competitive advantage for the company, thereby improving financial strength, business

operations are developed.

Part 3 Opportunity cost

According to Kennon J. (Dec, 2020), opportunity cost is the loss or gain of making a decision.

Simply, we can understand this definition by thinking of a normal case of a company that has a

empty store. If the company decides to expand production and use this space, hire more workers,
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buy more raw materials...to serve the extra production. The company needs to take into account

the opportunity cost, if not using the empty store to produce by itself, but leasing it, will the

revenues outweigh the profits from production expansion. If the rental was greater and the

company did decide to expand production, the company had unfortunately ignored the

opportunity cost. If the rental is less than the profit of the business expansion, the company

should decide to keep that space to expand production.

This example shows that accurately analyzing opportunity cost will help the company make the

right decision. However, the opportunity cost is not the total value of all the missed options.

Opportunity cost is considered to be the value of the best option, it meas one option which is the

best, since noone can use multiple alternatives at the one time.

Part 4

Business decisions

Obviously in any business activity, an ethical and visionary producer will not only think about

their own interests, but also the customers' interests and the impact on society as well. All three

objects are closely related to each other. Therefore, a good business decision for sure will brings

benefits to all three subjects.

“Voluntary transactions create wealth by moving assets from lower- to higher-valued uses”

(Froeb, L. M. et al., 2018, p.16).

Deontology and Consequentialism

Deontology is a theory that suggests actions are good or bad according to a clear set of

rules (Froeb, L. M. et al., 2018). Deontology is an ethical theory that emphasize the autonomous
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principle of moral conscience. For example, in my country – Vietnam, most of the lucky lotteries

seller are poor and disable people. They walk the whole day just to sell every single lucky lotery

to anyone they can approach. I myself rarely refuse buying each time they ask me to. I buy just

because I feel that they are so misfortune and I want to help them a little bit, not because I wish

to win the prize with that lucky lottery. This means I follow my conscience, despite of the result

whether I won the lottery or not, as long as I feel happy inside for an ethical behavior that given.

Unlike deontology, another theory that judges the result of action, is Consequentialism.

This theory states that the result of any action is the sole criterion for evaluating the true and

false of that action. Actually, from an economic point of view, this is the proper theory to

approach, compare to deontology, since the ultimate goal of business is existing results, visible

profits, not any kind of feelings that arise in conscience. However, this theory can lead to

unethical actions when the followers of course will tend to defy all paths to success.

Conclusion

In this essay, we have looked at demand elasticity as well as some basic economic concepts such

as sunk and opportunity costs, from which we have analyzed the effects of production on pricing

decision making. A narrow article with a few pages cannot mention in detail the benefits as well

as the characteristics, the impact factors of these costs and further matters. In addition, the

writer's limited knowledge as a student need to learn more about economics also makes the

article have some unavoidable limitations. Finally, regardless of the economic theory, with the

writer's personal point of view, each theory has its own advantages and disadvantages, people

need to reconcile many factors so that business results achieved come with the act not immoral.
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References

Kennon J., (Dec, 2020). What is opportunity costs?

https://www.thebalance.com/what-is-opportunity-cost-357200

Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2018). Managerial economics (5th ed.).

United States Department of Agriculture (December 29, 2020).

https://data.ers.usda.gov/reports.aspx?

ID=17825#P122ac3066b3e44a0af75c6ee36ca7253_4_214

https://data.ers.usda.gov/reports.aspx?

ID=17825#P122ac3066b3e44a0af75c6ee36ca7253_6_214