Consumer Products Inc: regional distribution and market strategy in western cities

CPI

Price elasticity of demand refers to the degree to which demand changes given a change in price. Consider an example, if we sell our toothbrushes for $2, and demand is 100. If we increase the price of toothbrushes to $2.10, how much does that affect demand? That is price elasticity. There are basically two types of elasticity -- elastic demand and inelastic demand (NetMBA, 2010).

Elastic demand is a situation where the demand changes at a greater rate than the price changes. If the scenario above, the price change is 5%. If the product's demand changes from 100 to 90 based on this increase, the price elasticity of demand will be 2, because the demand changed 10%, and the price changed 5%. The other major type of elasticity is price inelasticity of demand. Say the demand only fell to 98. Thus, the demand fell 2%, when the price increased 5%. This means the product has price inelasticity, because the change in demand is less than the change in price.

There are two other forms, but these are less common. Unitary elasticity implies a direct 1-for-1 relationship between price and demand. In this situation, that 5% increase in price would translate to a 5% decrease in demand, so the new demand would be 95. In practice, unitary elasticity of demand rarely holds over the long run. There is also reverse price elasticity of demand. Say we were selling our premium toothbrush at too low a price, so we increased the price to $3.00. Maybe consumers start thinking "hey, this is the best toothbrush on the market, and I want that." So they buy more, demand increases when the price increases. That is reverse price elasticity of demand, and it is normally only found in luxury goods, where the exclusivity of the higher price has value to the customer. Our products are not likely going to see reverse price elasticity of demand, but we do need to consider if we have elastic or inelastic demand because that is going to determine where our optimal point of profit is going to be.

If the firm is going to do business overseas, this will expose it to foreign exchange rate risk. If we produce in the United States, we will be subject to risk when we set our prices in British pounds, for example (Pietersz, 2012). The risk could be anywhere from 5-15% depending on how much the currency moves. The movements in the currency could move in our favor or against us. The company could produce in the UK, so that revenue there is spent there, but optimally we would not do that, and simply accept that there will be some risk. The risk is only realized, however, when the foreign currency is converted back to dollars, for example to buy more toothbrushes to sell. There is also translation risk, associated with reporting revenues and profits from foreign subsidiaries.

To mitigate transaction risk, the company could utilize a number of hedging strategies to lock in prices for foreign exchange, and this would allow us to adjust prices in local markets according to what we know the cost of production is. Most methods are fairly expensive, so only when the foreign business is large enough would we considered a forward contract, an interest rate swap, a futures contract or any other form of currency hedge.