What benefit can a business derive from an understanding of elasticity of demand?
The price elasticity of demand or PED is given by the percentage change in the quantity demanded by customers for a percentage change in the price of the product. The PED for most products is negative, i.e. an increase in the price results in a drop in demand and a decrease in price results in an increase in demand.
A business has to closely analyze the magnitude of the PED before making any change in the price of the products it sells. For products that have a high PED, a small increase in the price could drastically reduce the number of products that are bought and this would decrease the revenues of the business. If a product has a low PED, a business could increase the price of its products with the corresponding change in the number of products bought being very small.
There are also several products that exhibit a positive PED. Here demand rises with an increase in price of the products. Some examples of these are goods categorized as Giffen goods and Veblan goods. If a business does not analyze the PED of its goods to discover that the PED is positive, it may actually reduce profits by decreasing the price of its products with the expectation that doing so will increase demand.