Demand and Supply Are the Core Concepts

Demand and supply are the core concepts of economics and these are what determine the price of any given item. When demand of a certain item increases, it is usually followed by a corresponding increase in supply. And thus the price is affected. However there are times when demand increases more sharply than supply and this causes price to move up. In any case, price is directly dependent on supply and demand trends of a commodity. Price elasticity of demand refers to the economic condition when any change in price of a good and service generates some kind of response in its demand. When demand is affected by price, we know that quantity demanded is elastic. On the other hand when demand remains constant or change in price produces insignificant change in quantity demanded, we consider it a price inelastic situation. When a firm wants to change the price of a good or service, it needs to take a few things into consideration to find out if quantity demanded would prove to be elastic or inelastic.

Elasticity of demand is measured as:

proportionate change in quantity demanded

-proportionate change in price

Hayes Lemmerz International Inc. is the leading manufacturer of aluminum wheels in the world. While it enjoys 32% market share in North America, right behind its arch-rival Superior that has a market share of 37%, still when seen from a global perspective, Hayes is ahead of Superior in this field. Hayes wants to increase its market share in North America but can do this only if it lowers the price marginally because it's already a good number 2 in the field and a small price change can attract hordes of new customers. However before opting for a change in price strategy, Hayes must take the following things into consideration:

Rival and Substitute products:

Hayes must take into account all the substitutes present in the market for this product. Superior's aluminum wheels are already posing a threat since the firm enjoys a leading position in North American Market. Hayes must not forget the important rule that fewer the substitutes; lower the elasticity. In other words, when there are not too many alternative/rival products to choose from, the company's decision to change the price will not negatively affect demand.

Luxury or necessity: Hayes must first determine in which category its aluminum wheels fall. A luxury item usually has greater elasticity which means a small decrease or increase can have a significant impact on quantity demanded.

Consumer's budget: this is another consideration because if a certain item takes a great chunk of consumer's budget, any change in its price would produce significant change in its quantity demanded. Hayes must make sure that its average consumer's budget is not seriously affected by any price change.

Time period: Time during which elasticity is being measured must also be taken into account. For example when people are highly accustomed to using a certain product, they might not demand any less of it with slight price increase. But that behavior is only relevant in the short-term. Over a certain period of time, people adjust their behavior to their budgets and other factors and this can result in greater elasticity.

Permanent or Temporary: Hayes must also decide whether it would want to change the price temporarily or for good. This can have a serious impact on quantity demanded. Temporarily, a price change may generate greater elasticity than a permanent price change. For example a one-day promotional price change doesn't produce the same results as permanent price change.