Price Elastic Demand and Price Inelastic Demand
Introduction
In the highly globalised markets of today, firms actually coax their consumers to show their high demands for a certain product of that firm (O’Sullivan, A., Perez, S., & Sheffrin, S. 2006). When a customer does name his price, however, is very close to a demand curve. But what is Price Elasticity of Demand? This describes the relationship between the changes in the demands for the product and the changes in the price of the product.
“The most commonly used measure of the influence of price changes on consumers’ demand is the price elasticity of demand. The price elasticity is the ratio between the percentage change in quantity and the percentage change in price when there is a (small) change in price. Note that elasticity is not the same thing as slope; a demand curve’s slope is not a good measure as it depends on the units of measurement of price and quantity, making it difficult to compare across products or markets. Elasticity, on the other hand, deals with percent changes so that price sensitivities of goods and markets can be characterized using a common descriptor.” (Waldman and Jensen, n.d.).
The price is inversely related to the quantity demanded, ceteris paribus (Case, Karl E. & Fair, Ray C. 1999). However, given any change in price our demand does not change constantly and at the same percentage change of the price. Thus we may say that the price elasticity of demand measures how responsive the quantity demanded of a good is to a change in its price. Usually, our basic needs are considered inelastic while luxury goods are considered elastic. Basic goods have inelastic demand because we cannot easily shift from one good to another or give up them. This is because these goods are necessities. On the other hand, luxury products are considered products that show elastic demand because the change in price resulted more than proportionate change in quantity demanded. Luxury goods have elastic demand because we can shift from one good to another if the price is no longer reasonable. We can even give it up if the price is very high. For this paper, let’s consider the determinants of price elasticity/inelasticity of two types of products. For inelastic, we have bread products and for elastic we have shoe products.
Discussion
For elastic goods let us now consider shoe products and identify its determinants. When the price of a certain shoe products increased by almost half, we may immediately consider other shoe products in which price is much is lower. Thus with this, we may say that the price of the good in relation to our spending capabilities is a determinant. It can be argued that goods that account for a large fraction of disposable income have a propensity to be elastic.
Apparently, we as consumers often consider other substitutes of shoes. Thus we may say that the number of substitutes is a determinant. So instead of buying expensive shoes from Nike, we tend to go to their substitutes such as Adidas, Converse or Reebok or we may opt to choose buying sandals instead of close shoes as substitute. This means that the larger the number of close substitutes for the good then it is easier for us to shift to alternative goods if the price increases. Usually, the larger the number of close substitutes, the more elastic the price elasticity of demand.
In accordance to our shoe products, we may also say that the degree of necessity is also determinant factor of its elasticity (Mas-Colell, A, Winston, MD & Green. JR 1995). It means that if feel that we don’t really need to buy a new pair of shoes even the price of it is low, we tend to choose other products. Basically, the higher necessity items have little change in demand despite changes in price. Because they are “necessary” to survival, happiness, etc. people become willing to purchase them even when price changes occur. The following figure shows the perfect elastic demand.
Figure 1
In accordance to our inelastic products i.e. bread products. The determinants remain to be the price of the good in relation to our spending capabilities, number of substitutes, and degree of necessity.
So for bread products, even though the price of it increases, we still opt to buy this because we need it to fuel our body. Similarly, even tough there are number of substitute food products, we still choose to buy breads because of the nutrients it gives. Our consumers have no choice than to keep buying because substitutes are not freely available and easy to switch to (Thaler 1985). In accordance to degree of necessity, the necessity of this type of product is tremendously high thus regardless of the increases in prices, people opt to buy this product. The figure below shows perfect inelastic demand.
Figure 2
As seen in the above discussion, we have seen how responsive our demand is in accordance to the movement or change in price. And this is what we call elasticity (McCracken 1986). The price elasticity of demand can be computed by this averaging formula (Case, Karl & Fair 1999):
Where: epd = price elasticity of demand
= new quantity demanded
= old quantity demanded
= new price
= old price
Using this formula and using the quantity data below, we may try to compute the price elasticity. There are some instances that negative values will occur but this is only represents the inverse relationship between the price and the quantity demanded. And we just only need to get its absolute value. If epd is greater than 1, it is elastic and if less than 1, it is inelastic. The total revenue is the product of the price and quantity. This is the money of the seller’s hand at the end of the day. However, it is not yet his profit because he has not yet deducted the cost.
Table 1. Computed Elasticity and Its Classifications
Products
Qs
Total Revenue
epd
Nature
Bread Products
10
200
12
216
1.72
elastic
12
224
1.31
elastic
Shoe Products
16
224
18
216
0.76
inelastic
20
200
0.58
inelastic
References:
Case, Karl E. & Fair, Ray C. (1999). Principles of Economics (5th ed.). Prentice-Hall. ISBN 0-13-961905-4.
Goldman, A., & Sigismond, W. (2003). Business Law: Principles and Practices. Boston: Hough-ton Mifflin Company.
Mas-Colell, A, Winston, MD & Green. JR (1995). Microeconomic Theory. Oxford University Press, New York,
McCracken, G. ( 1986 ). “Culture and consumption: A theoretical account of the structure and movement of the cultural meaning of consumer goods”. Journal of Consumer Research, 13, 71-84.
O’Sullivan, A., Perez, S., & Sheffrin, S. (2006). Economics: Principles, Applications, and Tools (5th Edition). Alexandria, VA: Prentice Hall.
Thaler, R. ( 1985 ). “Mental accounting and consumer choice”. Marketing Science, 4, 199-214.
Waldman and Jensen. (n. d.). Industrial Economics (EC3066): Topic One: Schools of Thought. Retrieved January 09, 2009 from http://staff.bath.ac.uk/ecsjgs/Teaching/Industrial%20Organisation/Handouts/01%20-%20Schools%20of%20Thought/Handout%201a.pdf
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