How can a firm reduce its product's price elasticity of demand?

Answer 1

Before explaining how a firm can reduce it product's price elasticity we must understand why a firm would want to do such a thing, and the answer is simple! A firm can maximize its profits by increasing the price on inelastic goods because an Increase in price will cause a relatively smaller decrease in quantity demanded thus leading to higher total revenue.

Generally inelastic goods tend to be necessities such as; food, water, electricity ect so when price increases demand will more or less remain the same because people cannot do without food or water (or will consume less of them in the extreme). The task of a firm is to make their good more inelastic by reducing the amount and closeness of substitutes and this could occur in many ways such as;

Product differentiation - this is a marketing process that identities the differences between products. Differentiation looks to make a product more attractive by contrasting its unique qualities with other competing products.

Branding - Firms create differences in the minds of consumers between their product and those of other firms. This is achieved by differences in design of packaging of products as well as in the creation of brand names and trademarks. Once a brand has created a positive outlook among its consumers, the firm is said to have built brand equity. Some examples of firms with brand equity possessing very recognizable brands of products are; Microsoft, Ferrari, Coca-Cola, Sony, Nokia ect.

Successful product differentiation and branding creates a competitive advantage for the seller, as customers view these products as unique or superior. Thus the product's elasticity has been reduced because available substitutes are now relatively less close to their product.

Persuasive advertising - The primary goal is for a company to build selective demand for its product. For example, car manufacturers often produce special advertisements promoting the safety features of their vehicles. This type of advertisement could allow car manufactures to charge more for their products because of the perceived higher quality the safety features afford. This further reduces elasticity which in turn leads to higher total revenue.

Exclusive Dealing - This is when a firm which supplies well-known and popular goods to other small firms, may threaten them to sell only their products. If any of the small firms sell other products, the firm would no longer supply them with their products.

Predatory Pricing - this is when a firm sells a product at very low prices with the intention of driving competitors out of the market. If the other firms cannot sustain equal or lower prices without losing money, they'll go out of business. Once the smaller firm is out of business the larger firm can raise its prices once again.

The last two strategies completely eliminate substitutes meaning that the firm can charge higher prices since the demand has become inelastic and people have no choice but to buy that particular product. Firms which successfully reduce the elasticity of their product are able to generate more revenue.