A-AS Level (CIE) Business Studies Paper-3: Specimen Questions with Answers 20 - 20 of 20

Passage

Case Study-2

Adam, the owner of Ever-Joy Ice-Cream Center, near University Campus, was also a part time student of management studies in a Commerce College. After having studied the theory of price elasticity of demand, he thought that the demand for ice-cream should be price elastic. For an experiment ho announced special-reduced price for the Ever Joy Ice-Cream cone in the second week of August 2001 under the 54th Independence Anniversary Week. He observed the following sales outcome.

He Observed the Following Sales Outcome
AugustPriceTotal Sales
Regular
I week$ 51000
Special
II Week$ 41500

Finding demand elasticity to be much above unity, he inferred that the price reduction led the total sales revenue to increase. This outcome encouraged him to reduce the price in October on permanent basis to ₹ 4.50. To his utter surprise he found that his average weekly sales revenue rather declined to ₹ 4,770.

What happened? Though the average weekly demand had risen to 1060 with the price reduction the sales revenue declined. Because, this time the degree of price elasticity is demand suddenly become price inelastic? Why? What went wrong?

Adam՚s approach to price policy was purely theoretical, assuming all other things being equal. He did not care to look at other factors influencing the demand for ice-cream, such as possibilities like winter, climate adverse effects, similar price-war by the rivals shops in the area. Besides, Adam offered a 20 % price reduction temporarily in August only for a week, so most buyers responded to take the advantage and probably the rival did not retaliate knowing it was a short-term phenomenon at that time. Furthermore, now when the buyers realized that price- reduction in October is permanent, they did not react much on the buying-spree. In the previous case of price reduction, the buyers expected that in future - after the celebration work is over- price will go back to the original level, therefore, they purchased more. This phenomenon of further expectations was also not taken into accounting determining the later price-reduction policy. In short, the business excision of Adam was misled by overestimation of price elasticity from the very short-term data in a special situation rather than resorting to demand estimation based on the long-term sales data under normal circumstances.

From Adam՚s experience, we should learn one important lesson that any judgement based on an aerial view may not always be good. Besides, reality widely differs from theory. Real life is never simple as depicted in theory. Managerial decision making in practice is, therefore, more of an art than science.

Question 20 (10 of 10 Based on Passage)

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Essay▾

Explain the concept of perfectly elastic demand.

Explanation

  • Perfectly Elastic Demand is an endless demand at the given price is the case of perfectly elastic demand. When demand is perfectly elastic, with a slight or infinitely small rise in the price of a commodity, the consumer stops buying it. The numerical coefficient or perfectly elastic demand is infinity .
  • In a broad sense, the shape of demand curve is significant in ascertaining the elasticity of demand. In the case of perfectly elastic demand, the demand curve will be a horizontal straight line. Thus, the demand curve in Figure 6.1 (A) implies that at the ruling price of OP, the demand is infinite, while a slight rise in price would mean zero demand.
  • Figure indicates that at price OP a person would buy as much of the given commodity as can be obtained, i.e.. , an infinite quantity, and that even at a slightly raised price he would buy nothing. While it is assumed that when price is lowered, the demand curve shifts down at this price – the demand curve remaining horizontal. Perfectly elastic demand is a case of theoretical extremity. It is hardly encountered in practice.
Perfectly Elastic Demand

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