What are the possible disadvantages of price elasticity of demand to firms?
Elasticity of demand refers to how much the public will buy if the price of a good goes up or down. If the price of a good goes up too much, the public will find alternatives to the good. This is true of all market economies in which people essentially dictate the market with their money. An example of a good with an elastic demand would be a meal at a restaurant. If the restaurant raises its prices, people may look elsewhere for food--either going to a different restaurant or eating at home. A good with an inelastic demand would be a gallon of milk. While there are other things to drink such as water or juice, most people who are in the market to buy a gallon of milk will do so unless the price increases a great deal.
Companies are at a disadvantage when it comes to this elasticity if they do not know what price the market will support. If they mark the price down too much, the company may lose money if it costs more to produce the good than they are getting on the market. Also, too many consumers for a good will cause a shortage of it and one may lose customers if one cannot produce the good. However, if one raises the price too high, people may look for alternatives and will leave the overpriced good on the shelf. When the overpriced good becomes less expensive, there is also the possibility that the customer will continue to buy the other brand because it has become the new favorite.
Price elasticity of demand is only a disadvantage to a business if the business does not know how to determine how elastic the demand for its products is. Otherwise, elasticity of demand is simply a condition of a market economy.
Price elasticity of demand refers to how much the quantity demanded of a product changes when its price changes. We know that, all other things being equal, people will buy less of a product if its price rises. But we do not know how much less. This is where elasticity of demand comes in. If the price changes and the quantity demanded changes a great deal, we say that the demand for the good was elastic. If the price changes and quantity demanded stays relatively stable, we say that demand was inelastic.
Firms can be at a disadvantage if they do not know if their demand is elastic or inelastic. If demand is inelastic, a firm should raise prices. If it is elastic, the firm should lower prices. If the firm does not know which thing to do, it can lose money. Thus, a poor understanding of price elasticity of demand (and not the concept itself) can be a disadvantage to companies.