Evaluate the following statement: "The concepts of price and cross price elasticity of demand are of little relevance in determining the price decision of a firm."

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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This statement is not true.  The price elasticity of demand and the cross price elasticity of demand (also called cross elasticity of demand) can be very important in a firm’s decision on where to set its prices.

Price elasticity of demand is very important in knowing whether to raise prices on a good.  Price elasticity of demand tells us how much the quantity demanded of a product will drop if you raise the price by a given amount.  It tells the firm whether it will make more or less money by raising its prices.  This is, of course, a very important thing for a firm to know.

Cross elasticity of demand tells us what will happen to quantity demanded for one product if the price of another product changes.  For example, if you raise the price of tea, the quantity demanded of coffee is likely to go up because people might see these two drinks as substitutes for one another.  A business owner will want to take this into account when deciding on prices.  For example, if a grocery store carries two competing products and puts one on sale, it will have to consider both how the quantity demanded for the product put on sale will rise (this is price elasticity of demand), but also how much the quantity demanded for the second product will fall (cross elasticity).

Both of these concepts, then, are very important things to consider when a firm decides what prices it will charge.

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