A family friend is shopping for an exclusive Vera Wang wedding gown for $8,000 but feel that the price is excessive. She argues that the company should lower prices not only to benefit customers but also to increase the company's revenues and profits. What has she assumed about the price elasticity of demand for these gown?
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Elasticity of demand refers to the degree to which consumers are sensitive to changes in price. In general, an increase in price should lead to a decrease in the quantity demanded. The law of demand tells us this. However, it does not tell us how much of a decrease in quantity demanded occurs when the price increases. In other words, it does not tell us how sloped the demand curve is.
In some cases, a drop in price leads many more people to buy a product. When this happens, revenues actually go up because the increase in quantity demanded is sufficient to cause an increase in overall revenue. In this case, the demand for the product is said to be elastic. This is what your family friend is arguing about these dresses. She thinks that the demand for the dresses is elastic.
But in other cases, an increase in price leads to a very small drop in quantity demanded. The price goes up, but people still want the product. They are willing to keep buying and the overall revenue rises. The demand for such a good is said to be inelastic.
Thus, your friend has assumed that demand for these dresses is elastic instead of inelastic.
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