The market isÌýconstantly fluctuating based onÌýaÌýfew different factors, with supply andÌýdemand being two ofÌýtheÌýprimary driving forces. When aÌýproduct enters theÌýmarket, theÌýprice isÌýmost often determined byÌýtheÌýsupply andÌýdemand ofÌýaÌýproduct.
OfÌýcourse, when theÌýprice ofÌýaÌýproduct changes, this can cause aÌýripple effect inÌýtheÌýsupply andÌýdemand ofÌýsaid product. So, how does one measure these types ofÌýchanges?
The answer isÌýbyÌýcalculating theÌýprice elasticity ofÌýdemand.
The price elasticity ofÌýdemand isÌýessentially aÌýmeasurement ofÌýtheÌýchange inÌýtheÌýdemand forÌýaÌýproduct inÌýrelation toÌýaÌýprice change. InÌýother words, theÌýsensitivity ofÌýdemand andÌýquantity ofÌýaÌýproduct toÌýaÌýprice change. ItÌýisÌýcalculated through particular formulas andÌýdelivered asÌýaÌýpercentage amount.
Continue reading below toÌýsee how toÌýcalculate price elasticity ofÌýdemand andÌýmore about theÌýelasticities ofÌýtheÌýmarket.
Quick Answers
- Price elasticity ofÌýdemand isÌýused toÌýmeasure shifts inÌýtheÌýdemand forÌýaÌýproduct due toÌýprice changes.
- The formula forÌýprice elasticity ofÌýdemand isÌý“%ÌýChange inÌýQuantity ÷Ìý%ÌýChange inÌýPrice”.
- There are said toÌýbeÌýfive categories ofÌýelasticities: perfectly inelastic, inelastic, unitary elastic, elastic, andÌýperfectly elastic.
- Goods that see aÌýchange inÌýdemand with aÌýprice change are said toÌýbeÌýelastic. Goods that don’t see much change inÌýdemand asÌýprices change are considered inelastic.
- ItÌýisÌýbeneficial toÌýcalculate theÌýprice elasticity ofÌýdemand forÌýaÌýproduct, asÌýitÌýcan allow aÌýbusiness toÌýmake informed decisions regarding pricing strategies andÌýpolicies, andÌýcompetition, andÌýensure aÌýsteady revenue.
- Elasticity can beÌýaffected byÌýfactors like theÌýlength ofÌýprice change, theÌýnecessity ofÌýgoods, theÌýgeneral cost ofÌýtheÌýgoods, andÌýmore.
Formula toÌýCalculate Price Elasticity ofÌýDemand
Now that weÌýhave aÌýbit ofÌýunderstanding ofÌýthis concept, let’s look atÌýtheÌýformula toÌýcalculate theÌýprice elasticity ofÌýdemand.
The basic formula is:
Let’s look atÌýaÌýsimple example toÌýmake theÌýelasticity ofÌýtheÌýprice formula more clear:
Example: AnÌýapple stand typically sells 100Ìýapples aÌýmonth atÌýaÌýprice point ofÌý$1.00Ìýper apple. Due toÌýrising costs, theÌýapple stand opted toÌýincrease its price toÌý$1.20Ìýper apple. They are now only selling 85Ìýapples per month.
So, theÌýprice ofÌýapples saw aÌý20% increase, andÌýtheÌýdemand dropped byÌý15%. Now, let’s plug this into theÌýformula.
So, this price change led toÌýanÌýelasticity ofÌýless than 1%. There isÌýnoÌýcodified threshold, but theÌýcommon belief isÌýthat anyÌýchange under 1%Ìýindicates inelasticity.
ItÌýisÌýimportant toÌýnote that this isÌýtheÌýsimplest formula toÌýcalculate theÌýprice elasticity ofÌýdemand, but other formulas goÌýinto further detail.
One such formula isÌýtheÌý, which uses theÌýaverage percent change inÌýboth quantity andÌýprice.
The advantage isÌýthat theÌýformula will show theÌýsame elasticity between price points, whether there isÌýanÌýincrease orÌýdecrease.
The Types ofÌýPrice Elasticity ofÌýDemand
Depending onÌýtheÌýpercentage outcome ofÌýtheÌýformula, aÌýdemand curve can beÌýone ofÌýthree types. These are detailed below:
- Perfectly elastic: Price changes lead toÌýtheÌýdemand forÌýaÌýproduct declining toÌýzero.
- Elastic: AnÌýelastic demand means that changes inÌýprice create aÌýsignificant change inÌýtheÌýdemand forÌýaÌýproduct.
- Unitary elastic: Unitary elasticity isÌýwhere aÌýpercentage change inÌýprice isÌýmatched byÌýanÌýequal percentage shift inÌýdemand.
- Inelastic: Changes inÌýprice result inÌýaÌýsmaller percentage change inÌýdemand.
- Perfectly inelastic: Price changes result inÌýnoÌýchanges toÌýdemand.
What isÌýtheÌýValue ofÌýKnowing Price Elasticity ofÌýDemand?
Some may beÌýwondering what all ofÌýthese complex formulas andÌýexplanations amount toÌýforÌýactionable business information.
ItÌýmay seem like aÌýlot ofÌýnebulous data, but these calculations can beÌýused forÌýessential decisions within aÌýbusiness, including:
- Informed decisions about pricing strategies: Calculating how aÌýprice change has orÌýcould impact theÌýdemand forÌýaÌýproduct can allow aÌýbusiness toÌýmake informed changes. Instead ofÌýblindly making price changes based onÌýothers inÌýtheÌýmarket, they can change what works forÌýtheir goods. Additionally, itÌýcan allow aÌýbusiness toÌýfind andÌýset theÌýprice point that will result inÌýmaximum revenue while also being competitive.
- Improving customer image: Through carefully calculated pricing based onÌýthis formula, aÌýbusiness can price fairly while maintaining aÌýcompetitive edge. This can help them toÌýstand out toÌýcustomers over other brands andÌýcompanies.
- Taxation: The government uses this formula toÌýassign tax rates. They will often impose higher taxes onÌýgoods with inelastic demand, asÌýthey will not experience much demand change. This means that theÌýgovernment can count onÌýthem toÌýbring inÌýmore revenue. Good with anÌýelastic demand will beÌýonÌýtheÌýopposite side ofÌýthis.
- Market analysis: The formula price elasticity ofÌýdemand can beÌýused toÌýanalyze several facets ofÌýtheÌýmarket, including its condition related toÌýcertain goods, level ofÌýcompetition, alternative products available, andÌýmore. This data can beÌýused toÌýdetermine strategies forÌýcurrent goods, asÌýwell asÌýother markets that may beÌýworth exploring.
What Factors Affect Price Elasticity ofÌýDemand?
The price elasticity ofÌýdemand can beÌýaffected byÌýseveral factors, with four common ones including theÌýfollowing.
Type ofÌýgoods (necessity orÌýluxury)
The price elasticity ofÌýdemand will typically beÌýlower onÌýgoods that are aÌýnecessity, such asÌýmedicines orÌýmedical devices. The elasticity will beÌýhigher onÌýgoods considered toÌýbeÌýaÌýluxury. Additionally, discretion can play aÌýsignificant role inÌýtheÌýelasticity ofÌýdemand.
AnÌýexample would beÌýaÌýconsumer considering buying aÌýnew car, but their current vehicle isÌýworking fine. IfÌýtheÌýprice ofÌývehicles goes up, they are likely toÌýhold off onÌýpurchasing aÌýnew car until theirs breaks orÌýprices come back down.
Length ofÌýprice change
The length ofÌýtime ofÌýaÌýprice change can play aÌýsignificant role inÌýconsumer elasticity. The change inÌýdemand will beÌýmuch different forÌýaÌý
For example, ifÌýaÌýconsumer’s favorite ice cream goes upÌýbyÌýaÌýdollar forÌýtheÌýsummer, they may decide toÌýdeal with theÌýprice change orÌýfind anÌýalternative forÌýtheÌýseason. Whereas aÌýpermanent price increase may cause them toÌýswitch brands.
Availability ofÌýsubstitutes orÌýalternatives
Price elasticity ofÌýdemand can beÌýaffected ifÌýconsumers have substitute options available that are similar toÌýtheÌýproduct. IfÌýalternatives are available, theÌýdemand would beÌýconsidered elastic. IfÌýthere are noÌýsubstitutes forÌýtheÌýgood, itÌýwill result inÌýinelastic demand.
AÌýgood example ofÌýthis isÌýwith technology. AÌýconsumer who wants aÌýMacBook will unlikely buy aÌýcheaper Windows laptop, asÌýitÌýisÌýnot aÌýsuitable enough alternative.
How much income isÌýspent onÌýtheÌýproduct
The general price point ofÌýgoods can play aÌýrole inÌýtheÌýdemand elasticity asÌýwell. IfÌýtheÌýgoods are relatively inexpensive andÌýnot aÌýsignificant portion ofÌýaÌýperson’s income, their purchase may beÌýunchanged byÌýaÌýprice change. Whereas goods that cost aÌýlarger proportion ofÌýaÌýperson’s income, consumers are less likely toÌýhave anÌýelastic demand toÌýprice changes.
Let’s look atÌýtheÌýice cream example from above. IfÌýconsumers love their favorite ice cream enough, they are often willing toÌýcontinue buying itÌýafter aÌýprice change. OnÌýtheÌýother hand, ifÌýaÌýconsumer has their car detailed forÌýanÌýaffordable price previously andÌýitÌýjumps up, they may start cleaning their car themselves.
Wrapping Up
WeÌýhope that this detailed look into theÌýprice elasticity ofÌýdemand will allow you toÌýmake more informed decisions forÌýyour business. ByÌýemploying theÌýformula above, you can make accurate price changes that will maximize revenue andÌýkeep consumers happy.
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- How toÌýCalculate Price Elasticity ofÌýDemand