Question

2. During a recession when people's incomes drop, grocery chains experience much smaller declines in sales than do upscale department stores. Explain this phenomenon using the concept of elasticity.

Answer 1

---> A recession is a significant decline in economic activity, lasting more than a few months and marked by decline in real gross domestic product, real income, employment, manufacturing, and retail sales. In a recession, consumers are likely to have lower income and be more sensitive to prices. There is also the threat of unemployment which will make consumers more reluctant to spend. During recession, firms or grocery stores are likely to see a fall in demand and unsold goods. This creates an incentive to cut prices. Firstly the fall in demand puts downward pressure on prices. Secondly in a recession, demand is likely to become more price elastic (more sensitive to changes in price). Therefore, a firm may be able to increase revenue by cutting price. In a recession, a cut in price may have bigger percentage increase in demand than in normal circumstances. Thirdly, in a recession, firms are more likely to experience cash-flow problems and risk going out of business. With unsold stock and liquidity problems, there is a clear incentive to offer big discounts to bring in revenue and help survive the economic downturn.