Price Elasticity of Demand is an economic term used to describe the relation between quantity demand and price changes. It gives the change of quantity demanded or purchased in accordance with alteration in cost using percentage. Based on this data, a firm can determine whether its products are elastic or inelastic.
The price elasticity of demand tells us whether the product is vulnerable to changes in price or not.
- Elastic Products – When the changes in price significantly affect the quantity of demand or purchase of a product, they are called elastic products.
For example, let us consider a toy factory. If the prices of the toys rise radically, then people will find it easier to replace those toys with some others. This results in quantity of demand decreasing. Hence the toys manufactured by this factory are an elastic product.
- Inelastic Products – When the changes in price do not cause a significant change in the quantity of demand or purchase of a product, they are termed inelastic.
For example, a company that manufactures brand cars will enjoy uninterrupted demand even if their prices are increased. Such is the case with many luxury goods. Customers pay for the privilege of using them.
Calculating the price elasticity of demand
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The price elasticity of demand is a percentage value of the relation between prices change and quantity demand. It is calculated using a simple formula given below.
Price Elasticity of Demand = % Change in Quantity Demanded / % Change in Price
This value is not an independent determiner. Several determinants affect the calculation of this economic factor. Some of these determinants are given below:
- Alternative options – If there are readily available substitute products in the market, the customer can switch brands easily, making the product elastic. Whereas when there is less competition, the product tends to remain inelastic.
- Essentiality – Some goods are irreplaceable like food and medicines. They can remain inelastic with price changes. But, the consumers can adapt their need to the availability of other products. For example, very few people use tooth powder today even if their cost is affordable. With time the needs of people change and along with it the quantity demand.
- Time period – The behaviour of customers also depends on the duration of the price changes. For example, changes during a sale can result in drastic change in quantity demand. Whereas the changes that occur gradually can maintain the inelasticity of the product.
Along with these determinants there are plenty others such as brand loyalty, income percentage, etc that affects the price elasticity of demand.
Importance of the price elasticity of demand.
Price elasticity of demand is a very helpful tool for companies to predict consumer behaviour and align themselves to receive maximum benefit. This measure has to be carefully tracked throughout the products lifetime.
It is used to determine the maximum profit a company can gain and at what price. This helps the company run parallel with the consumer market and experience maximum revenue. This measure also helps us understand effect the changes in the cost have on the product’s market performance. This can help the company design a pro-consumer product that will fetch them ideal results.
Consumers respond, to a large extent, predictably to the changes in price for either an elastic or inelastic product. They either look for an alternative or stick to the product. A company should decide how they want their consumer to behave and accordingly design their goods price.