Why is elasticity an important concept for a business

Your Money. Personal Finance. Your Practice. Popular Courses. Business Business Essentials. Business Essentials Guide to Mergers and Acquisitions. Table of Contents Expand. What Is Elasticity? How Elasticity Works. Types of Elasticity. Factors Affecting Demand Elasticity. The Importance of Price Elasticity. Examples of Elasticity. Elasticity FAQs. The Bottom Line. Key Takeaways Elasticity is an economic measure of how sensitive an economic factor is to another, for example, changes in supply or demand to the change in price, or changes in demand to changes in income.

If demand for a good or service is relatively static even when the price changes, demand is said to be inelastic, and its coefficient of elasticity is less than 1. Examples of elastic goods include clothing or electronics, while inelastic goods are items like food and prescription drugs. Article Sources. Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate.

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Investopedia does not include all offers available in the marketplace. Related Terms Understanding the Cross Elasticity of Demand The cross elasticity of demand measures the responsiveness in the quantity demanded of one good when the price changes for another good.

What Is Income Elasticity of Demand? This can also be seen when it comes to the types of goods the government chooses to tax.

Cigarettes and gasoline are two products that have price inelasticity. If your business is an ambulance service, you have a high degree of demand inelasticity because when a consumer needs your service, they will not go elsewhere if your price is higher than your competitor.

Customer loyalty has a stabilizing effect on the market, that is, it makes demand less elastic. When customer loyalty is a factor, you can charge a little bit more than your competitor without adversely affecting sales because demand will not respond as significantly to pricing. This is the value behind branding.

Branding your company or your product creates customer loyalty, which makes market demand less elastic. The quality of your product or service has an effect on elasticity as well. Therefore, elasticity can often be an inexact calculation. Avery points out that in a digital context, this is easy and inexpensive to do. Understanding the why behind consumer behavior is critical to predicting how they will respond in the future. Therefore, smart marketers supplement any quantitative testing with qualitative research to get at the underlying reasons for consumer behavior.

Ultimately, you want to stay relevant to consumers and differentiated from your competitors. Once you do that, you can adjust price up or down to better represent the level of value you are providing to your customers. Your current price elasticity is just one data point that helps you make those future decisions. Read refreshers on net present value , breakeven quantity , debt-to-equity ratio , and cost of capital. Price elasticity is, therefore, an extremely fascinating topic to research upon for marketing experts.

Through a market study, they could produce an inelastic demand for their product. It would give them an edge over their competitors apart from boosting the market position of their brand.

A groundwork by comparing their product to those of others. Price Elasticity of Supply refers to the change in the supply of a good or service in relation to the change in its market price. The basic economic theory says that the supply of the items increases when their price increases. Likewise, its supply decreases when its market price decreases.

In the economic system, producers or manufacturers are constantly competing for profits. As the profits can never be the same across products and time, they tend to invest more in the goods that show a good profit; leaving out the less profitable ones. This phenomenon is said to be related to the law of supply. Often, this economic concept is also called the Cross Price Elasticity of Demand. It is calculated by dividing the percentage change in the quantity demanded of one good by the percentage change in the price of the other good.

Cross elasticity is a measure of how change in one product impact another product. This is useful to determine, with a high degree of confidence, if products are interlinked. Substitute Goods : For substitute goods, the value of cross elasticity is always positive. This is due to the increase in demand for one good when the price of other goods increases. As evident from the formula, both the numerator and the denominator indicate positive increases.

Unrelated goods have a zero coefficient as they are independent of each other. When the goods have low cross elasticity, they are called weak substitutes. Example: tea and coffee. Conversely, related goods are strong substitutes such as two different brands of coffee.

The price change of one brand affects the demand of the other brand. Complementary Goods : Contradictory to the substitute goods, the cross elasticity of demand for the complementary goods is negative. It states that as the price of one good increases, the demand for its closely associated item also decreases. This is because the cost of the main product has increased. Understand it this way: If the cost of tea increases, the consumers are less likely to buy teabags. As the cost of the main product increases which is tea here, the demand for tea bags also decreases.

From the formula, the numerator value denoting the demanded quantity of tea bags is negative and the denominator denoting the price of tea is positive.