The main characteristic of demand is elasticity, which shows the buyer's reaction to a change in the price of a product.
This indicator can be associated not only with changes in prices for goods, but also with variation in consumer income. Thus, income elasticity and price elasticity of demand differ .
To understand the nature of the indicator, you should study the behavior of the buyer associated with price fluctuations. A person’s reaction to changes in product prices can be weak, strong and neutral. Any case generates a corresponding demand, which can be single, elastic or inelastic. There may be options when demand becomes completely inelastic or completely elastic.
Price elasticity of demand has quantitative characteristics and is expressed through the corresponding indicator. This is the coefficient of price elasticity of demand. It equals the ratio of the percentage change in sales to the percentage change in price. It turns out that demand is considered elastic even with its significant fluctuations, which can lead even to insignificant changes in prices. If the price decreases by 1 percent, then the elasticity increases by a larger value.
You can consider an example. In conditions of great competition, the company lost half of its customers, despite the fact that the price increased by only 5 percent. In this case, the price elasticity coefficient is 10 (50% divided by 5%), and since it is greater than the unit value, demand is elastic.
Knowing the law of demand and its elasticity, we can draw some conclusions.
A price increase cannot guarantee an increase in revenue from sales, and a decrease in the value of a product does not always lead to its fall.
When setting the price of goods, any company must calculate what revenue it will receive, given the price, taking into account the existing elasticity of demand.
With a relatively low coefficient, the demand for products is considered inelastic. This occurs when selling essential goods, when selling products for which it is difficult to find analogues. Inelasticity arises with the relative cheapness of the goods, as well as with the hopeless situation of the buyer.
Minimum price elasticity of demand (inelasticity) means that buyers are sluggishly reacting to price changes. The volume of purchased goods increases by less than one percent by 1% reduction in the price of this product.
The intermediate number between inelastic and elastic demand is the value of this indicator, equal to one. Such a situation may arise, for example, when a double price increase leads to the same decrease in the volume of purchased goods. At the same time, total sales revenue does not change.
It happens that in different situations the same type of product has different elasticities.
Knowing what the price elasticity of demand for a particular product is, one can draw practical conclusions. After all, a change in price can affect the amount of total revenue in different ways. Thus, a decrease in value with elastic demand leads to an increase in total revenue. It is proved that cheaper products stimulate buyers, and the gain received from an increase in the number of sales will more than cover the losses from a decrease in prices.
Everything happens the other way around with inelastic demand. Revenue and price move in one direction. A decrease in the latter reduces total revenue, since it does not lead to a massive expansion of sales. And with an increase in value, revenue increases, since the gain from a rise in price of goods covers losses due to a relatively low reduction in sales.
A good example is paying for public transport services. With its constant increase, inelastic demand decreases by an insignificant amount, and the revenue of transporters grows.