Price Elasticity of Demand

Running head: PRICE ELASTICITY OF DEMAND

Price Elasticity of Demand

Team Paper

University of Phoenix

Price elasticity of Demand

With the objective of increasing the company’s revenue, we have been tasked by Hyundai Motors to determine if the company should increase or decrease the price of its Sport Utility Vehicle (SUV), Santa Fe. We will use the price elasticity of demand concept to determine what actions should be taken. Additionally, we will determine the impact on demand for the Santa Fe if the incomes of Hyundai customers increase by 10 percent. We will use the income elasticity of demand concept to help us determine that impact. Our goal is to help the company determine the best unit price to maximize revenue. We will begin with some background information on the vehicle.

Here is some background information on the vehicle. The Hyundai Santa Fe’s first year of production was 2001. Not only was it their first Suburban Utility Vehicle (SUV), it was also Hyundai’s first vehicle designed with American consumers in mind, "We saw that this SUV market was defined by chunky, truck-platformed models such as the Cherokee, Xterra, Wrangler, Explorer, 4Runner and the Blazer," said Hyundai's U.S. president Finnbar O'Neil, "and even though these vehicles sell well, we found they have a high level of dissatisfaction with certain characteristics that relate to their frame design." (The Car Connection, n.d) Overall, we have several years of data to help us determine the best course of action.

Price elasticity of demand for the Santa Fe is determined by comparing the change in quantity demanded to the change in price. Economists measure the degree of price elasticity or inelasticity of demand with the coefficient Ed, defined as:

percentage change in quantity

demanded of product X

Ed = -----------------------------------------

percentage change in price

of product X

The percentage changes in the equation are calculated by dividing the change in quantity demanded by the original quantity demanded and by dividing the change in price by the original price. (McConnell-Brue, 2004) A demand is elastic “if a specific percentage change in price results in a larger percentage change in quantity demanded. The Ed will be greater than 1.” (McConnell-Brue, 2004) A demand is inelastic if the percentage change in price produces a small change in demand. The Ed will be less than 1. Finally, a demand is unit elasticity when the change in price is equal to the change in demand. Here the Ed will be equal to 1. (McConnell-Brue, 2004) Understanding elasticity of demand is the key to maximizing the company’s revenue.

Determining how the current price of the Santa Fe affects the elasticity of demand will indicate if we should increase or decrease the price of the vehicle. If demand is elastic a price increase will decrease total revenue and a price decrease will increase total revenue. If demand is unitary elastic the demand will not change with either a price increase or decrease. Finally, if demand is inelastic a price increase will increase total revenue and a price decrease will decrease total revenue. (McConnell-Brue, 2004) Our recommendation to Hyundai is to adjust the price of the vehicle, either positively or negatively, until the elasticity on demand is unitary elastic. This action will produce a market price that will enable a sustained production output equal to market demand while maximizing the company’s total revenue.

We have described how the price elasticity of demand can be used to determine if Hyundai should increase or decrease the price of the Santa Fe to increase overall revenue. We will now use the income elasticity of demand to determine how a 10% increase in customer income could potentially affect the demand for the Santa Fe.

A 10% increase in customer income could possibly affect demand for the Hyundai Santa Fe positively. Statistics show that households with higher incomes tend to have more than one vehicle. So a Hyundai customer who gains a 10% income could decide