Have you ever heard of elasticity of demand? It is an economic term, yes, but where mathematics also comes into play. And for companies it can be very important because with it you can detect how if the price of a product changes, it will affect supply or demand.
But how much do you know about this element? If you want to know it in more depth, and also understand it, we will explain it to you below.
What is elasticity of demand
The first thing you should keep in mind, as we said at the beginning, is that The elasticity of demand is an element that identifies what happens if a price is varied (up or down) in the supply or demand of a product.
In other words, the elasticity of demand can help us know what happens if there is a change in price in supply or demand.
For instance, Imagine that you have a product that everyone wants: tobacco. This has been increasing its price to prevent more smokers and so that people's health is not put at risk. However, no matter how much it increases, smokers continue buying, and although there are some minimums that stop them, more also come in. That is to say, we have that the price has increased and, contrary to what could happen, the demand has not decreased, or we could even say that it has increased.
On the other hand, we have streaming platforms. Each time they have been increasing the price, which causes demand to decrease, also because there are many offers.
Elasticity of demand: elastic or inelastic
If you look at the two examples that we have just given you, in one of them it does not seem that the price increase affects demand, while in the other it does cause it to fall.
When a product or service rises in price, and people still buy it, It is said that we are facing an inelastic elasticity of demand.
On the contrary, when the price change causes demand to rise or fall, it is classified as elastic.
Now, these two types, although they are the most common, are not the only ones. You can also find:
- Relatively inelastic demand. In this case there is a change in demand, yes, but this is less than that caused by the change in price.
- Relatively elastic demand. Like the previous one, due to this price change, demand drops, but this is not so significant to achieve it.
- Unit elastic demand. It is one where the change in demand produces, in the price, a proportional change.
What factors influence demand
Focusing now on the elasticity of elastic demand, there are some factors that determine the greater or less elasticity of that demand. The most important are the following:
- The needs. A product or service that is for simple fun is not the same as one of necessity. For example, a subscription to video games on a console will not be the same as buying olive oil for cooking. If the need is important to that person, the demand will not fall, but will remain the same, while if it is something to do without, then it will fall.
- Substitute goods. That is, the possibility that there are substitutes for that good or service that has increased the price. If there are, and they are of quality, many people will forego purchasing the first one over the other brand.
- The expense of that good. Imagine that you have a pencil that cost you 10 cents. Two months later you go to buy another one and instead of 10, they ask you for 15 cents. Although there has been a price increase, the truth is that, since it is a good that takes time to be spent and the amortization between one price and another is small, then demand will not vary too much. But if there is a lot of difference, things change.
- Price. You should know that, depending on prices, the elasticity of demand may be higher or lower. In general, when prices are high, demand is less elastic than if they were cheap products.
How to Calculate Elasticity of Demand
The next step we must take regarding the elasticity of demand is to know its formula. To do this, you must keep in mind that we are talking about a division. You have to divide the percentage change in quantity (demand) by the percentage change in price.
That is to say:
Elasticity of demand = % change in demand / % change in price
Based on this, the result can be:
- Greater than 1. It means that you are facing an elastic demand.
- Under 1. Then the demand will be inelastic.
- 1 exact. You would have a balance or proportionality of demand (although this is very rare.
- If it reaches 0 or is very close. It would indicate that the changes that have been made in quantities have nothing to do with demand.
Example of application of the formula
Imagine that you go to a bookstore to buy a notebook. This one costs one euro. But when you go back for another one he tells you that it now costs one and a half euros. This has meant that, when he calculates those who buy them, he realizes that he has gone from having 40 sales to only 23.
First you need to know the % change in demand. That is, knowing what percentage there is from having 40 sales to going to 23. Dividing 40 by 23, multiplying it by 100 and then subtracting 100, we obtain that the proportion is 74% (rounding).
For its part, now we take care of the price change. And we do the same with which we get 50%.
We apply the formula:
Demand elasticity = 74% / 50%
Demand elasticity = 1.48%
Which tells us that it is elastic.
As you can see, the elasticity of demand can be an element that indicates the consequences of a price increase or decrease with respect to the demand or lack thereof for that product or service. Do you have more questions? We solve them for you.