Friday, February 10th, 2012
There’s an economics principle you might benefit from understanding because it can increase your revenues – the price elasticity of demand.
Price Elasticity – Petrol at $4 per Litre
If petrol rose in price tomorrow at your local bowser to $4 per litre would it affect the amount of petrol you would want to purchase? Contrast that answer to the opposite end and think how you would react to a $0.50 decrease instead. Would that affect your purchase?
Of course the change would affect the amount that you were willing to purchase. This is an economics calculation your local supermarket is always tweaking when it offers 2 -for-cheaper deals and specials. The supermarkets don’t just guess at the price elasticity of demand; they pretty well know how given groups will react to the price changes of specific products because they hire economists to continually rethink their calculations.
Cigarettes and Elasticity / Inelasticity of Demand
A single product may affect different people, in that different groups may have differing price elasticities of demand for that product. A simple example of this is to consider cigarettes.
Somebody with an inelastic demand will tolerate rather large increases in price with little or no effect on the amount of the product they are willing to purchase. In contrast to somebody who has elastic demand who will not buy the product with even a small price increase.
Nicotine addicts have an inelastic demand. New and aspiring smokers have an elastic demand. If you double the price of cigarettes tomorrow the (inelastic) addicts will fork out double the cash (with a grumble) and the (elastic) newbies will look to another vice.
There is only so much more money we are willing to pay for a good or service and that depends on some pretty predictable drivers.
Inelasticity of Demand is about that Price Stretch
If you’re a little confused about the terms elastic and inelastic don’t be worried, it’s quite simple.
An addict has inelastic demand, meaning that even though the price doubles overnight they are pretty much caught up in the buying of cigarettes regardless of the price. So, for a greater increase in price you will only see a few of those nicotine addicts quit smoking.
The new or aspiring smoker is said to have elastic demand. Even a small increase in price means a greater proportion will not purchase the cigarettes.