Customers and Changing Costs
We can see that understanding elasticity helps a firm set a price that maximizes total revenue. What happens if the firm’s production costs change, though? And what is the impact on customers?
Most businesses are continually trying to figure out ways to produce at a lower cost, as one path to earning higher profits. It is a challenge to do this, though, when the price of a key input over which a firm has no control rises. If the cost of a key input rises, can the firm pass along those higher costs to consumers in the form of higher prices?
For example, many chemical companies use petroleum as a key input, but they have no control over the world market price for crude oil. Coffee shops use coffee as a key input, but they have no control over the world market price of coffee.
Conversely, if new and less expensive ways of producing are invented, can the firm keep the benefits in the form of higher profits, or will the market pressure them to pass along the gains to consumers in the form of lower prices? The price elasticity of demand plays a key role in answering these questions.
