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.
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
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.
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
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.
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.
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.
- 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. Factors affecting inelastic demand, on the other hand, include infrequent purchasing, a lack of substitutes, geographical location, and whether the product is a basic necessity.
Read Next: Pricing Strategy.
Connected Economic Concepts
Positive and Normative Economics
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