As technology advances, our lives become more and more centered around digital goods.
Many modern industries now require digital access rather than physical access to revenue. This is a huge shift in the way business is done.
For example, imagine a music streaming service that allows users to listen to unlimited music for a set price per month. This service would need enough users to subscribe in order to make a profit, but how does the company ensure they get as many users as possible?
They would have to find the point where the demand for their service is elastic- that is, the point where adding or removing a small price change will affect the number of subscribers.
This article will discuss how to identify when demand for a product or service is elastic or inelastic, and how this information can be used in business strategies.
Cause a 4 percent or less increase in the quantity demanded
Inelastic demand means that when the price of a good or service goes up, people need to spend more money on it.
For example, if your car needs a new transmission, you will have to pay a certain amount for it regardless of how much it costs.
If the price of cars went down by 4 percent, people would not buy any more cars because they do not need any more cars. They already have one that works!
Inelastic demand is a good thing for businesses. When they cut prices in half, they will still get the same amount of sales. This will help them save money and make more of it.
Cause a less than 4 percent decrease in the price of X
In this case, a company would see a drop in revenue, but not a drop in profit. A company with an inelastic demand for its product will see a rise in price and fall in sales, thus lowering profit.
When the price of a good or service falls, demand tends to rise, which offsets some of the loss in price. When the price of a good or service rises, demand tends to fall, which likewise offsets some of the gain in price.
When the price of a good or service rises, and there is no change in demand, then there is no real change in total revenue or profit. There is only a change in who receives it.
If there is an increase in demand at the current price then total revenue will increase.
Cause a 4 percent or more decrease in the price of X
In this case, a company can lower the price of the product and still maintain their expected level of revenue. This is due to the fact that a reduction in price will not cause a reduction in demand.
Consumers will buy the product at any price below the one that would make them choose something else instead. This is good news for companies who have products with inelastic demand.
If they want to clear out inventory, they can do so without losing revenue. They can even afford to be generous with their prices without worrying about lost revenue.
If the demand for Product X is elastic, then a 4 percent decrease in the price of X will cause a 4 percent decrease in revenue. In this case, dropping the price will cause a loss in sales, which companies should try to avoid.
Assess whether your product is elastic or inelastic
To determine if your product is elastic or inelastic, you must first understand what those terms mean. Elastic products respond quickly to price changes, meaning that demand will increase if the price drops.
For example, if coffee prices went up, more people would buy tea as a substitute because it is less expensive. People would still buy coffee even if the price went up because it is a preferred beverage.
Inelastic products do not respond to price changes very much. If the price of a vitamin water goes up, people will probably just buy another brand of vitamin water or just drink plain water instead. There is little to no substitutes for an inelastic product.
You can assess your own product via an online survey or by doing a blind study. In the survey, ask people what other products they use as substitutes and whether the price of your product affects how often they purchase it.