We'll begin with two scenarios to illustrate price elasticity of demand. First, there is a particular movie you want to buy on DVD, but the price is rather high when the movie is first released, so you decide to wait for a while before you buy. The next time you check, the price has gone up even a little further, and you notice that there are quite a few copies still on the rack. Apparently, other potential customers have also decided to wait. The store has noticed this, too, and the next time you shop, you are surprised to see that the price has dropped significantly. It is well within your payment comfort zone, so you snatch up the second to last copy. This is a prime example of an “elastic” product. The higher the price, the less demand there is for the product. As the price drops, however, the demand increases.
Now think about another scenario. You are required to make an overnight trip for business, and you need to put gas in your car. You notice that gas prices have risen some since the last time you filled up, but since your car would be running on fumes by the time you reached your destination, you make the purchase anyway. In this case, the product is “inelastic.” Demand doesn't vary too much according to the price.
Now let's think about how price elasticity affects businesses and their decisions. Returning to the first scenario, we can see that price elasticity has affected how the store sets the price of the movie. At first, thinking that the movie would be in demand even at a higher price, the store charged more for each DVD. When that didn't work and the DVDs stayed on the rack, it dropped the price, recognizing the elasticity of demand. So businesses often set and change their prices based on the elasticity of demand. Further, stores and firms might develop marketing campaigns to lead consumers toward accepting higher prices.
In the second scenario, the gas station raises its prices according to factors other than elasticity of demand. However, that still affects the business, for as prices go up, it needs to develop strategies to help satisfy grumbling customers. A station might, for instance, develop a new advertising campaign or a customer rewards program to help offset higher prices. It might even drop prices on other products.
Knowing the price elasticity of demand for their products helps firms set proper prices, plan ahead for product releases, monitor consumer trends, and develop useful business and advertising strategies.
The price elasticity refers to the degree of responsiveness of demand as a result of a change in price.
The price elasticity of demand is important to firms because it helps them in pricing their products. The firm needs to know whether their product has an elastic or inelastic demand.
A product with elastic demand is more responsive to a change in price. Such goods have numerous substitutes; therefore, the consumer...
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can go for another brand if their favorite company is charging more for the product. If the firm finds out that their good has elastic demand, they might try to differentiate the product from others. Differentiation can help them charge a higher price for a while, but in the long-run consumers will still go for the most affordable item. As a result, most firms tend to focus on producing more elastic goods. Since they can’t increase the price as much as they’d like to, they have to produce more in the hopes that they will sell more and increase revenues.
On the other hand, a good with inelastic demand is less responsive to changes in price. You can increase the price, and the quantity demanded won’t change by much. If a firm’s products have inelastic demand, the firm can practice price discrimination in different markets. The firm can charge more in a neighborhood with high-income individuals.
Price elasticity is important to firms because it will influence the price they will charge for various products or services. If a product has an elastic demand, it means that the amount demanded will change as the price of the product changes. Businesses will need to closely monitor how the demand for their products change as the price changes. For example, if the price of milk doubles, it is likely that the demand for milk will drop since it is a product with an elastic demand.
If a product has an inelastic demand, businesses don’t need to be as sensitive to changes in price mainly because people will need to have that product or service regardless of its price. A good example of this would be the cost to visit a doctor. If a person was really sick and in urgent need of medical care, it is likely that person would pay whatever price was charged to visit the doctor. A person probably wouldn’t shop around for the best rate. A similar situation exists with oil. As oil prices rise, people will still buy gasoline because they need to get from place to place. While they might reduce oil consumption to some degree, people still have a need for the gasoline and will purchase it.
Knowing the price elasticity of a product or service will impact the price the business can charge for it. It also will allow a business to develop marketing and pricing strategies that will allow it to potentially maximize its profits and hopefully reduce its risks.
Price elasticity of demand is a measure of change in quantity demanded of a commodity relative to a change in its price. If the demand is inelastic, an increase in price results in increased revenue. If the price rise results in decreased revenue, the demand is elastic.
Knowing the price elasticity of demand, a firm can decide on an optimum price level of their commodity to achieve their revenue targets. Price elasticity information can help them decide how much price reduction is necessary to increase revenue to a certain target, or what level of price increase will be optimal (since extra revenue from a price increase may be wiped out by decreased demand).
The knowledge of price elasticity of demand also helps firms in devising their marketing strategies and targeting niche segments. An example is high net worth individuals whose demand for luxury is inelastic and hence hotels advertise suites to them. On the other hand, budget travelers have an elastic demand and hence are targeted for 'Standard' rooms.
Why is price elasticity of demand important in modern business?
The price elasticity of demand is an economic concept that describes the change in demand that accompanies a change in price. If a good has an elastic demand, consumers will not be willing to purchase as much of it if its price rises. On the other hand, if a good or service has an inelastic demand, people will continue buying it at higher prices, probably because they need it.
Understanding, and being responsive to, demand elasticity is important for businesses at any time, and especially if they are in a highly competitive economic sector. If, for example, a property manager or owner calculates that she can rent apartments at $1,000 a unit when, in fact, few are willing to rent at that price, then she will have to lower the rent and may lose her investment in the process with the resulting falling revenues. She failed to account, in short, for the elasticity of housing demand.
So, understanding the principle of price elasticity of demand is important to businesses in pricing the goods and services they offer.
Further Reading
Why is price elasticity of demand important in modern business?
Price elasticity of demand is a measure that tells how the quantity of an item that can be sold varies when the price of the item varies. If a firm raises its price and its revenues decline, the item it is selling has elastic demand. The more the revenues go down, the more elastic it was.
By contrast, if the firm raises its prices and revenues go up, the demand for the item was inelastic.
As you can see from this definition, it is important to know if demand for a product is elastic or inelastic. Knowing this will tell a business how to set its prices for maximum profit.
Why is the concept of price elasticity of demand important to a business?
The concept of price elasticity of demand or PED is very important for a business in pricing its products appropriately to achieve the required sales revenue.
Price elasticity of demand is the percentage change in the quantity demanded for a percentage change in the price of the product. If a business is selling a product that has a very small PED it could, in theory, increase the price by a large extent with the corresponding decrease in demand being very small. This is the case for essential goods where the demand is relatively inelastic.
On the other hand, if the PED is large, even a small increase in price will reduce the demand by a large value. Businesses that sell products that have a relatively elastic demand have to price their products very carefully to obtain enough sales revenue to ensure that their operations are profitable.
Further Reading
Why is the concept of price elasticity of demand an important concept in business management?
The concept of price elasticity of demand is a very important concept in management because it helps managers know how to price the goods or services that they sell.
The law of demand states that consumers will be willing and able to buy less of a product as the product’s price goes up. However, the law of demand does not tell us how much less of the product customers will buy if the price goes up by a given amount. If the price of the product goes up 10%, will the quantity that customers buy drop by 10%? Will it drop by 1%? Will it drop by 15%? This is where the concept of elasticity comes in. Price elasticity of demand is a measure of how much the quantity of a product that consumers demand will change in response to a change in price.
It is very important for a manager to know this. If you were managing a store and you knew that you could raise the price of an item 10% and only lose 1% of your sales, you would do it. But you would not raise the price if you knew that a 10% price increase would cause you to lose 15% of your sales. Thus, knowledge of the price elasticity of demand tells us whether to raise prices on our products. This is why it is an important concept for business managers.
Further Reading