Price Elasticity of Demand

(1) Why is it that a profit-maximizing businessman would always raise prices when facing an inelastic demand curve, but might or might not raise prices when facing an elastic demand curve? Explain and justify your answers in detail.

Price elasticity of demand is defined as percentage change in quantity demanded divided by the percentage change in price. If the demand is elastic, consumer response is large relative to the change in price (e.g., new car, airline travel). If demand is inelastic, consumers aren't very responsive to price changes (e.g., cigarettes, coffee).

So based on concept of price elasticity, businessman's total revenue may increase or decrease. When he raise prices, If demand is inelastic, when he increases prices his total revenue will actually increase because consumer response to a price raise was small because of inelastic demand, buyers will keep purchasing regardless of price increase. If businessman raises prices when demand is elastic, then his total revenue will decrease. Because consumers reaction will be higher to the change in price and that will result less consumption which means reduction in total revenue. All suppliers want to increase their revenue so they can get a bigger profit.

In conclusion, an elastic demand curve price and total revenues go in opposite directions; in an inelastic demand curve they go the same direction. So faced with an inelastic demand curve, a businessman can make more revenues. If the businessman faces an elastic demand curve, his revenues will go down if he increases prices. So depending on how elastic the demand is for his product and how his costs are affected his profits may go up or down.

(2) You own a fresh vegetable stand. Last week you decided to raise your carrot prices from 79 cents per bunch to 99 cents per bunch. Subsequently, you noticed that several of your regular customers were buying 2 bunches instead of their usual one. In fact, your carrot sales had gone up appreciably. When you finally asked one of your customers why she was buying so many carrots, she replied, "My neighbor told me that you had recently raised your price because carrots were in short supply, and that I ought to stock up before you ran out." Does this contradict the law of demand? Why or why not? Justify your answer.

According to law of demand, the quantity of a good demanded in a given time period increases as its price falls or quantity of a good demanded decreases if the price increases, ceteris paribus (the assumption of nothing else changing). There is an inverse relationship between the price of a good and the quantity demanded. However, there might be instances in which consumers behave by determinants of demand such as; tastes (desire for this and other goods), income (of consumers), expectations (for income, prices, tastes), other goods (their availability and price), and number of consumers in the market. The demand is