The advantages of the elasticity of demand

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The advantages of the elasticity of demand
Bread has low elasticity of demand: many people buy the same amount regardless of cost (Comstock/Comstock/Getty Images)

Elasticity of demand refers to how sensitive the quantity of demand for a particular product or service is to price changes. Elasticity calculations don't measure demand (which is the underlying, fundamental desire that consumers have for a product) but rather quantity demanded: how many units consumers are prepared to buy at a particular price. Having an idea of the elasticity of demand for a good can help inform pricing and planning decisions and planning.

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Definitions

Elasticity of demand is a mathematical relationship. It measure the relationship between a proportional change in price and a proportional change in how much of the product consumers as a whole are willing to pay at that price. The more the price affects the quantity demanded, the more elastic the good is considered to be. Goods where prices have little or no effect on quantity demand are considered as inelastic.

Factors

Several factors affect elasticity of demand. A key one is whether consumers see the good as a necessity or luxury: elasticity is lower with necessity goods such as basic foodstuffs because customers feel the need to buy them even if the price rises, but likely won't start buying more of them just because they become cheaper. Demand is more elastic if there are many close substitutes for the good, or if it is particularly cheap and easy to switch to alternatives. Some goods can have differing levels of elasticity when you break them down into more specific groups: for example, train tickets at peak commuter times tend to have less elastic demand than those at times preferred by leisure travellers.

Advantages for consumers

Good with particularly elastic demand can be better for consumers because they create an incentive for sellers to keep prices low. The more elastic the demand, the more likely it is that the fall in revenue per unit will be outweighed by the rise in quantity sold. This can be limited by the make-up of the manufacturer's costs however: manufacturers are aiming to maximise profit, not revenue.

Advantages for manufacturers

Some manufacturers can benefit from goods having more elastic demand. With these goods, customers are more likely to change brands or products based on price. This makes such products particularly attractive to manufacturers that are able to cut production costs and thus afford price cuts. This could also benefit companies that are able to quickly enter new markets when they spot an opportunity to undercut existing producers.

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