At 99 cents, you could buy a bottle of Coke on impulse.
At $ 1.09, you can still grab this drink off the shelf if it’s near the cash register.
At $ 1.19, you might be spending the money on a particularly hot day.
At $ 1.29, you might feel uncomfortable spending that much on the war on enamel.
At $ 1.39, you are out. Nothing will convince you to buy that bottle of Coke.
You just know the elasticity of demand.
What is elasticity of demand?
Elasticity of demand occurs when external factors such as price and the environment influence the amount of a product that consumers buy. You see it in your everyday life more often than you think. Consider, for example, the last time you went to the grocery store and saw the sale items completely sold out. This is elastic demand in action.
High elasticity of demand indicates that consumers easily react to external factors when purchasing a given product. Take our grocery store example above; a slight drop in the price of chicken drumsticks could lead to an increase in consumption. Or think of umbrellas, a very elastic market depending on weather conditions. When it rains, people buy them. In good weather, they buy very little.
Most consumer products tend to have moderate to high elasticity.
Low elasticity of demand indicates that consumers tend to buy a product regardless of price changes or external factors. Gasoline is a classic example of a low elasticity product. Both workers and travelers have to drive, so as prices go up people tend to cut back on spending in other areas, rather than buying less gasoline. As a sole necessity, there aren’t many factors that will convince people to change their gasoline buying habits.
Unit elastic demand occurs when a change in price has a 1: 1 relationship with a change in consumption. In other words, for every 1% that you change the price, consumption also changes by 1%. Few, if any, products exhibit true unit elasticity.
What is driving the demand?
Price is the most common demand influencer, usually with an inverse correlation. As prices rise, consumer interest tends to decline and vice versa. This is called the âprice elasticity of demandâ. (It should be noted that the price can sometimes influence other demand factors. For example, in the alcoholic beverage industry, the price can influence the perception of quality by consumers, resulting in a reversal of the relationship. normal where consumers actually prefer a brand more as its price moves up.)
While price elasticity is a major component of total demand elasticity, there are many factors that can influence consumption patterns. These are often cited as the five or six determinants of demand. These are generally:
Product price: When the price of a product increases, consumption tends to decrease. When the price of a product falls, consumption tends to increase.
Consumer income: As consumers’ incomes increase, so does consumption. As the income of consumers decreases, so does consumption.
Consumer Preferences: This is perhaps the broadest and most ambiguous defining category. It refers to what consumers want for a given product, and can be motivated by perception, advertising, environmental factors, and anything that will make a product more or less popular (a can of Coke in hot weather, an umbrella in rainy weather etc).
Ease and price of substitution: for a given product, as the availability of a substitute increases and the price of that substitute decreases, the consumption of the product decreases. Essentially, as consumers can replace a product more easily and at a lower cost, the consumption of that product will decrease. This is sometimes called cross elasticity.
Anticipated Price: If consumers believe that the price of a product will increase in the future, demand will increase. If the consumer thinks that the price of a product will drop in the future, he will tend to wait for his purchases.
Market segment: Elasticity is also strongly determined by the profile of the consumer. For example, wealthy consumers will generally be very price inelastic, while urban consumers may have high cross elasticity due to their access to a crowded market.
As discussed above, âhigh elasticityâ means that consumers tend to react easily to any of the factors listed above. Typically, luxury goods, branded and fungible goods, and entertainment tend to have higher elasticity.
For example, a brand-driven product will tend to have high elasticity by substitution. This means that consumers can easily replace this product with a comparable product. A good example is paper towels. There is little practical difference between kitchen towel products, so most consumer purchases are driven by brand loyalty; someone who buys Bounty will tend to continue to do so. However, if a competing brand of paper towels lowers its price, consumers will quickly switch to competition because the products are easily substitutable.
It is also a factor in how retail stores plan their sales. When consumers know a sale is coming, they tend to stop buying in anticipation of falling prices. Thus, retailers often do not announce their next sales. On the other hand, during this sale, a retailer will usually post the end of the discount. This will encourage consumers to buy more of a product, in anticipation of higher prices.
With a very elastic product, this sales model will prove to be effective. With an inelastic or “low elasticity” product, it won’t. Consumers will continue to buy them in constant numbers, regardless of how they think future prices will move.
Low elasticity means that consumers do not easily change their buying habits, regardless of the factors listed above. A product could become more expensive or the external conditions could change and consumers will always buy the product in constant numbers. Low elasticity of demand is generally associated with necessities, health and safety related products and irreplaceable goods.
In addition to gasoline, listed above, cigarettes are a classic example of an inelastic product. Many smokers are motivated by physical habit. This means that they will continue to buy cigarettes even if prices increase or shopping becomes inconvenient. Few, if any, external factors will change how badly a person with a nicotine habit wants to smoke, and many states are taking advantage of this through lucrative taxes.
Healthcare is another inelastic market.
Patients have very little control over the amount of care they consume. If you have a broken bone, you need to get it fixed. If you are sick, you need the right medicine. Therefore, prices and market conditions have very little impact on the amount of health care purchases. Consumers are going to go into debt and go bankrupt because at the end of the day it’s a physically coercive market: you consume more health care or suffer from pain, disease and perhaps death. This leads to great inelasticity.
What is artificial inelasticity?
Managing elasticity is an essential factor for good policy making, and many (if not most) economic policies are structured around the influence of demand on the market.
For example, consider the Federal Reserve which changes interest rates. The purpose of an interest rate change is to encourage or discourage borrowing and, by extension, business spending. The key underlying factor is the price elasticity of capital. In essence, to what extent will the consumption of capital (borrowing) change with changes in prices?
Many other government policies revolve around creating or restricting artificial inelasticity.
Through the patent and copyright system, for example, the government artificially creates a highly inelastic surrogate market. Without these laws, people could easily copy the work of scientists and artists, creating an almost infinitely elastic market. Without copyright laws, someone could just transcribe John Grisham’s latest novel verbatim, charge $ 1, and create immediate cross-elasticity.
Intellectual property laws exist to stop this. They make competition by simple price and substitution impossible, forcing other authors to compete for consumer preference. (In other words, by writing a better book.)
The antitrust system, on the other hand, is an example of regulation away from artificial inelasticity. Monopolies allow a business to eliminate all substitute competition by making itself the only product on the shelf. By dismantling these monopolies, the government strengthens competition and by extension this form of consumer elasticity.
It is important to note that a product can have varying degrees of elasticity depending on different demand factors. Something that is very elastic by consumer preference can also be very inelastic by price and vice versa.
For example, novels are a good example of a product that has varying degrees of factor elasticity. As an entertainment product, consumers will tend to lose interest in a paperback quickly the more expensive it becomes. This product has high price elasticity.
Yet this also tends to be a very unique product. A fan of John Grisham won’t simply replace his latest thriller with a space opera, regardless of the price difference between the two. This product has a very low elasticity of substitution.
High elasticity is a one-factor question. If a factor can cause people to buy less of the product, then it has a higher elasticity. Low elasticity is a net factor. If, all things considered, no demand factor significantly changes consumption, then this is a product with low elasticity.