Elastic demand definition
/What is Elastic Demand?
Elastic demand occurs when the price of a product has a large impact on the quantity purchased. A product is said to have elastic demand if sales drop sharply in response to an increase in price, or sales spike when prices are decreased.
From a pricing formulation perspective, elastic demand is of great concern. If it is not possible to increase prices without experiencing a sharp decline in sales volume, a business must rely on cost reductions or expansion into new sales regions to generate a profit over the long term. Price elasticity is particularly common when the products of competing companies are not well differentiated, or where substitute products are readily accessible.
Conversely, a company is in a much better position when customers are willing to accept price increases and still maintain approximately the same sales volume, thereby increasing company profits. Inelasticity arises when a company can clearly separate the features of its products from those of competitors, and customers assign value to these differences.
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How to Calculate Price Elasticity
Elastic demand can be calculated by dividing the percentage change in unit demand by the percentage change in price. The formula is as follows:
% Change in unit demand ÷ % Change in price = Elasticity of demand
Example of Elastic Demand
Country Poles manufactures multi-segmented aluminum walking poles for hikers. It normally sells 10,000 units of its primary product per year, at a price of $40 for each pair. Due to an increase in the cost of aluminum, the company is forced to increase the price to $45, which results in a decline of 2,000 units sold in the following year. This represents price elasticity of 60%, which is calculated as follows:
20% Change in unit demand ÷ 12.5% Change in price = 60% Elasticity of demand
Elastic Demand vs. Inelastic Demand
Elastic demand occurs when the price of a product has a large impact on the quantity purchased, while inelastic demand occurs when the prices changes have little impact on demand. The key differences between these concepts are as follows:
Consumer response. Under elastic demand, consumers are highly responsive to price changes, while consumers are not very responsive to price changes under inelastic demand.
Existence of substitutes. There are usually several substitute products available when there is elastic demand, while there may be none at all when there is inelastic demand.
Revenue impact. Under elastic impact, lowering the price increases total revenue, while raising the price decreases revenue. Conversely, when there is inelastic demand, raising the price increases total revenue, while lowering the price decreases revenue.
Terms Similar to Elastic Demand
Elastic demand is also known as price elasticity of demand.