Price elasticity measures the responsiveness of the quantity demanded or supplied of a good to a change in its price. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes. Price elasticity, therefore, is a measure of how consumers react to the price of products and services.
Table of Contents
Understanding price elasticity
Consumers are sensitive to the price of a product or service when deciding whether to make a purchase decision. While most consumers are more likely to purchase a cheap product and less likely to purchase an expensive product, the role of price in the decision-making process is more nuanced.
Gasoline is one example of a product with inelastic demand. Consumer demand for the product is less responsive to price changes because it is considered a vital commodity. Common products with elastic demand include soft drink, cereal, clothing, electronics, and vehicles. Consumers are more responsive to changes in price because these products are not considered necessities and there are readily available substitutes.
Price elasticity data is valuable to a marketing team. The data enables them to determine how the market will react to price changes to existing products and whether such a reaction will impact the company’s bottom line.
The four types of price elasticity
There are four types of price elasticity, with each used to explain the relationship between two economic variables:
Price elasticity of demand (PED)
A measure of the change in consumption of a good or service in relation to a change in its price.
Price elasticity of supply (PES)
A measure of the change in the supply of a good or service in response to a change in its price.
Cross elasticity of demand (XED)
This is a measure of the change in demand for one good in response to a change in demand for another good.
Income elasticity of demand (YED)
A measure of the change in demand for a good in response to a change in the buyer’s income.
Factors that affect elastic and inelastic demand
In the introduction, we touched on some of the factors affecting elastic and inelastic demand. Let’s take a more detailed look at these below.
Factors affecting elastic demand
Available substitutes
When there are many products of a similar type available, those with a lower price are more attractive than those that are more expensive. Chocolate bars are one example.
Homogenous products
Similarly, the presence of homogenous products gives consumers more choice and freedom. Demand for insurance is not affected by price increases because there is always a provider offering cheaper premiums.
Lower switching costs
If there are no costs associated with switching products, then demand is less likely to be impacted by price. For example, there is no cost to the consumer in switching to Mercedes if they consider BMW sedans to be too expensive.
Factors affecting inelastic demand
Purchase frequency
Consumers tend to spend more money on one-off purchases such as a new car or smartphone.
Lack of substitutes
If there are no suitable alternatives, then demand tends to be elastic. For example, demand for milk does not change if prices rise by 10% because for most people, there is no substitute.
Geographical location
Some goods and services are inelastic because a company has geographical dominance. In most sports stadiums, food and beverage retailers can raise prices without affecting demand because fans have no choice but to purchase from them.
Basic necessities
Some products are necessary to survival, including medication, electricity, water, and some food items. Demand for these goods and services is unresponsive to price changes.
Case Studies
Gasoline
Gasoline is a classic example of a product with inelastic demand. Even if the price of gasoline increases, consumers still need to purchase it for their vehicles. The demand for gasoline is relatively unresponsive to price changes because it is considered a necessity.
Soft Drinks
Soft drinks like cola or soda often have elastic demand. Consumers have various choices and substitutes available. If the price of a particular brand of soda increases, consumers may opt for other brands or switch to alternatives like water or juice.
Luxury Cars
Luxury cars, such as high-end sports cars or luxury sedans, often have elastic demand. Consumers in this market segment are more sensitive to price changes due to the availability of substitutes and alternatives. If the price of a luxury car increases significantly, consumers may opt for a different brand or model.
Prescription Medications
Prescription medications typically have inelastic demand. People who require specific medications for their health conditions are less likely to be price-sensitive. Even if the price of a medication increases, patients may continue purchasing it to maintain their health and well-being.
Air Travel
Air travel can have both elastic and inelastic demand depending on the situation. For leisure travelers, air travel might have elastic demand as they can adjust their plans based on price fluctuations. However, for business travelers who need to attend meetings or conferences, air travel could have inelastic demand as they are less flexible with their travel plans.
Luxury Watches
Luxury watches are often associated with elastic demand. Consumers interested in luxury watches have various brands and models to choose from. If the price of a particular luxury watch increases significantly, consumers may explore other options or brands that offer similar prestige.
Generic vs. Brand-Name Medications
When comparing generic and brand-name medications, generic medications tend to have more elastic demand. Generic medications are often cheaper alternatives to brand-name drugs, and consumers may switch to generics to save money while achieving the same therapeutic benefits.
Fast Food
Fast food items like burgers or fries can have elastic demand. Consumers have numerous fast-food options, and they can easily switch to a different restaurant if prices increase. Fast food chains often engage in competitive pricing to attract customers in this price-sensitive market.
Air Conditioning in Hot Climates
In regions with extremely hot climates, the demand for air conditioning can be inelastic. Even if electricity prices rise, consumers may still need to use air conditioning to stay comfortable and protect their health during hot weather conditions.
Public Transportation
Public transportation, such as buses and subways, can have both elastic and inelastic demand. For daily commuters who rely on public transportation to get to work, the demand might be inelastic, as they need it for their daily routine. However, for occasional travelers, the demand could be more elastic as they have the flexibility to choose other transportation options.
Key takeaways:
Price elasticity is a measure of how consumers react to the price of products and services. It can be described as elastic, where consumers are responsive to price changes, or inelastic, where consumers are less responsive to price changes.
Price elasticity data is valuable to a marketing team. This data enables them to determine how the market will react to price changes to existing products and whether such a reaction will impact the company’s bottom line.
Factors affecting elastic demand include available substitutes, homogenous products, and lower switching costs. On the other hand, factors affecting inelastic demand include infrequent purchasing, a lack of substitutes, geographical location, and whether the product is a basic necessity.
Key Highlights:
Price Elasticity:
Price elasticity measures the responsiveness of quantity demanded or supplied to changes in price.
It can be elastic (responsive) or inelastic (less responsive) based on consumer reactions to price changes.
Consumer Sensitivity to Price:
Consumers consider price when making purchase decisions, and their sensitivity varies.
Gasoline has inelastic demand due to its vital nature, while products like soft drinks, electronics, etc., have elastic demand due to available substitutes.
Types of Price Elasticity:
Price Elasticity of Demand (PED): Measures change in consumption with respect to price change.
Price Elasticity of Supply (PES): Measures change in supply due to price change.
Cross Elasticity of Demand (XED): Measures change in demand for one good due to change in demand for another.
Income Elasticity of Demand (YED): Measures change in demand based on buyer’s income change.
Factors Affecting Elastic Demand:
Available Substitutes: Many similar products with lower prices attract consumers.
Homogeneous Products: Multiple choices impact demand, like insurance.
Lower Switching Costs: No cost in switching products, e.g., car brands.
Factors Affecting Inelastic Demand:
Purchase Frequency: High spending on one-off purchases like cars or smartphones.
Lack of Substitutes: No alternatives available, making demand less responsive.
Geographical Location: Dominant companies can raise prices due to lack of choice.
Basic Necessities: Essential goods like medication or utilities have unresponsive demand.
Value of Price Elasticity Data:
Valuable for marketing teams to assess market reaction to price changes and impact on company’s profits.
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State capitalism is an economic system where business and commercial activity is controlled by the state through state-owned enterprises. In a state capitalist environment, the government is the principal actor. It takes an active role in the formation, regulation, and subsidization of businesses to divert capital to state-appointed bureaucrats. In effect, the government uses capital to further its political ambitions or strengthen its leverage on the international stage.
The boom and bust cycle describes the alternating periods of economic growth and decline common in many capitalist economies. The boom and bust cycle is a phrase used to describe the fluctuations in an economy in which there is persistent expansion and contraction. Expansion is associated with prosperity, while the contraction is associated with either a recession or a depression.
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The bottom of the pyramid is a term describing the largest and poorest global socio-economic group. Franklin D. Roosevelt first used the bottom of the pyramid (BOP) in a 1932 public address during the Great Depression. Roosevelt noted that – when talking about the ‘forgotten man:’ “these unhappy times call for the building of plans that rest upon the forgotten, the unorganized but the indispensable units of economic power.. that build from the bottom up and not from the top down, that put their faith once more in the forgotten man at the bottom of the economic pyramid.”
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The Easterlin paradox was first described by then professor of economics at the University of Pennsylvania Richard Easterlin. In the 1970s, Easterlin found that despite the American economy experiencing growth over the previous few decades, the average level of happiness seen in American citizens remained the same. He called this the Easterlin paradox, where income and happiness correlate with each other until a certain point is reached after at least ten years or so. After this point, income and happiness levels are not significantly related. The Easterlin paradox states that happiness is positively correlated with income, but only to a certain extent.
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In Economics, a Diseconomy of Scale happens when a company has grown so large that its costs per unit will start to increase. Thus, losing the benefits of scale. That can happen due to several factors arising as a company scales. From coordination issues to management inefficiencies and lack of proper communication flows.
An economy of scope means that the production of one good reduces the cost of producing some other related good. This means the unit cost to produce a product will decline as the variety of manufactured products increases. Importantly, the manufactured products must be related in some way.
Price sensitivity can be explained using the price elasticity of demand, a concept in economics that measures the variation in product demand as the price of the product itself varies. In consumer behavior, price sensitivity describes and measures fluctuations in product demand as the price of that product changes.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
