For example, people continue to buy cigarettes despite price increases because they’re addicted to them. Supermarket own-brands would lose demand to competitors quickly after a price increase, because there are a lot of other beans available.įor addictive goods, there are no substitutes for many consumers. For example, Heinz Beans has a strong identity of ‘it has to be Heinz’, which makes customers loyal and more likely to tolerate a price increase.Ī version of beans without brand value wouldn’t benefit and see demand fall more sharply. Some brands hold enough value to be less elastic than competitors with similar products. Those consumers would move their attention (and their spending) from one form of entertainment to another. If someone could purchase anything else instead of what you sell, that counts as a substitute in price elasticity.įor example, if customers found Netflix too expensive, even a book could substitute for it. When you consider substitutes for your product, it’s not just similar things to acknowledge. A slight price reduction could mean a high increase in demand as you take customers away from competitors. The critical point, though, is it also works in the opposite direction. If you raised the price of yours, people would buy a slightly cheaper alternative. If there’s high competition in a market, it’s easier to find an alternative.įor example, there are many cereal brands. A price change that would more severely affect a buyers budget will lead to greater demand elasticity. Customers will still have a breaking point where they decide the cost is far beyond its necessity.Īgain with the petrol example, if the cost rose too high, you might see people switching over to electric vehicles.Įlastic products have many acceptable substitutes that customers decide to purchase instead. The affect a change in price has on the customers budget also affects elasticity. If you have an inelastic product, though, that doesn’t mean you’re able to charge as high a price as you’d like. If the price increased they’d still buy it, so it’s unlikely to impact demand. Uber’s surge pricing, the rapid rising of prices when demand is high, to make sure that their taxi drivers go to the location where prices and demand are high. This company uses price elasticity formulas to manage demand on one hand and to increase profit margins on the other hand. If you were to reduce your prices by 10% and as a result sales increased by 15% the demand would be considered elastic and the elasticity of demand would be -1.5.Inelastic products are either necessities, addictive or luxury.įor example, petrol is a necessity for many people’s transport. Here you could argue that this product is price elastic. In this case the price elasticity of demand would be -0.5. If you raise your prices by 10% and sales fall by only 5% this is referred to as inelastic demand. If you raise your prices by 10% and sales fall by 10% this is regarded as a neutral position and referred to by economists as elasticity of demand of -1.0 (note that the minus indicates the negative relationship and the demand curve slopes to the right – see the diag). Few businesses know the relationship between price and volume. In general if you raise your prices you will sell less and if you lower them you will sell more. If the price of nuts and bolts changes, they cannot consume more because their need is determined by the volume output of whatever they are used in. People buy nuts and bolts and motors and chemicals to use as components in things they make. Typical products here are those used in industrial applications. When a change in the price of a product has very little effect on its demand it is inelastic. These are products people need and so a reduction in their price encourages purchases in greater volume. If the price elasticity is equal to 1.5, it means that the quantity of a product's demand has increased by 15 in response to a 10 reduction in price (15 / 10 1.5). As we will see, when computing elasticity at different points on a linear demand curve, the slope is constantthat is, it does not changebut the value for elasticity will change. Products that have a high level of elasticity are foodstuffs, particularly basic food items. The price elasticity of demand is the ratio of the percentage change in quantity to the percentage change in price. Think of this small price change as stretching (ie elastic) the market considerably. Products have high elasticity if a small change in price results in a large change in demand. It describes the relationship between the price of the products and the demand for those products. The price elasticity gives the percentage change in quantity demanded when there is a one percent increase in price, holding everything else constant. Price elasticity is an important concept in business.
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