Importance of Price Elasticity of Demand, Essay Example

One of the most important economic concepts for business may be price elasticity of demand which helps us measure the proportional change in demand that may result from a particular proportional change in price. In other words, if price changes by a certain percentage, by what percentage the demand will change. Since price and quantity demanded has negative relationships, we ignore the negative sign for the sake of simplicity and measure the price elasticity of demand in an absolute amount.

If the price elasticity of demand is between zero and one, we called it inelastic. It is equal to one, we call it unit elastic and a price elasticity of demand greater than one is elastic. When price elasticity of demand is inelastic, it means the percentage change in quantity demanded is below the percentage change in price. Unit elastic means the percentage change in quantity demanded is same as percentage change in price and elasticity means the percentage change in quantity demanded exceeds percentage change in price. This concept has great applications when it comes to pricing strategy.

If the demand for a product is price inelastic, the business increases its revenue by increasing price. If the demand is unit elastic, either increasing or decreasing the price will result in same total revenue but if the quantity demanded of a product is elastic, the revenues will decrease if the price is increased and vice versa. The following example shows how inelastic demand results in greater revenue when price is increased even if the number of units sold may be less. This is because the loss in sales is more than made up by an increased price.

In the above example, demand declined when price increased from $10 to $11 but since the price elasticity of demand was inelastic, actual revenue increased from $1,000 to $1,045.

The goal of the firm is usually to achieve an inelastic demand because it signifies greater pricing power. In fact, it is one of the major objectives behind marketing campaign. Greater pricing power results in higher profit margins and also provides some protection from the competition. Knowledge of price elasticity of demand also allows the firm to gauge itself against the competition. The competitor with lower price elasticity of demand may be the one with the greatest pricing power and customer loyalty and may also be the industry leader.

Thus, not only price elasticity of demand concept helps an organization understand its pricing power but also helps the organization compare itself with the competition or evaluate whether its differentiation or other marketing strategy may be working. An enhanced brand perception should result in lower price elasticity of demand. I hope I have made a strong argument for embracing this concept at the organization.