Price Elasticity and Currency Fluctuation in CPI
Consumer Product Inc experiences a lot of challenges in management and its survival in the market is limited because of the stiff competition from other big companies dealing with same products on expansion. It therefore requires macroeconomic policy review for its existence.
Price elasticity as it relates to economics is a measure of the responsiveness of demand or supply to change in price. Elasticity itself measures responsiveness. If demand changes by more than the price has changed, the good is price elastic but if demand is by less than the price, it is price inelastic.
Substitution elasticity in Consumer Product Inc can be calculated on the basis of a one level utility that is a function of domestic output and quantities imported by all countries taken together. Hence changes in relative prices among different exporters are assumed away. The most recent studies on the products where Consumer /products should adapt to avoid spurious correlations and obtain long term relationships. The method has found that statistically, significant estimates for long term elasticity submissions vary from almost zero to less than five in the US as well as in Brazil (Batista, Isaac 2005)
Within a particular company like CPI, there are homogenous products whose prices from tend to equalize through arbitrage, so that the suppliers are price takers under perfectly competitive markets. This will apply a specification that assumes in perfect competition which will tend to overestimate the substitution elasticity, since the individual suppliers of these products are confronted with perfectly elastic demand curves.
Since the products of all the divisions of the Consumer Products Inc are priced in US dollars, the pass through effect in the US will tend to be underestimated as the suppliers in the countries like Brazil and Germany are the price –takers, hence their relative prices are insensitive to changes in Real and Euro currencies for Brazil and Germany respectively.
Studies have shown that the law of one price cannot be rejected for a number of very narrowly defined commodities. Further, there are indications that homogeneous goods following the law of one price is more easily found amongst manufactured commodities that go through basic industrial processing than within the group of primary goods.
Also it is important to determine from which countries this company is getting most of its revenue and which country exposes. It is not easy to find a breakdown of currency revenue but nowadays because global business is important to investors, companies often break down foreign revenues in public announcements about their earnings. Any company finance officer (CFO) when it comes to foreign currency should have a question in mind, ‘Am I comfortable with that particular foreign risk? Is this to benefit the company?’ (Market Oracle 2010)
If the US dollar is weakening relative to the currency that makes up an important share of the company’s oversees revenue, then stock will realize positive return from that revenue. When the foreign earnings are converted back into dollar, foreign earnings will be able to buy more dollars when they are translated back to the US currency, hence a profit boost.
Hedging foreign currency is a risky business. Besides knowing the risk, you still have to get the liming right when you put a hedge. If you put on a hedge, it amounts to putting another speculative position which if not executed properly can expose the company to a great loss.
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