The elasticity and inelasticity of demand determine how the demand for a product responds to the change in any economic factor such as its price. To put it simply, it considers how people react toward a product when there is a certain price change.
Of course, there are other economic factors to determine elasticity like substitute availability, income level of consumers, etc. But the price is the most common factor that businesses use to calculate elasticity. Hence, if a product's demand changes with the price change, it is elastic. On the other hand, demand is inelastic if it remains constant regardless of price changes.
To understand the difference between elasticity vs inelasticity of demand, let’s take a deeper dive based on the most important factors. Also, in the end, we will discuss how it helps businesses in decision-making.
Elasticity vs Inelasticity of Demand: 5 Main Differences that Companies should know
Understanding the differences between price elastic and inelastic demand would help companies achieve a competitive edge in the market as and when they implement strategic pricing strategies based on demand response. Let’s study the differences based on definition, types of commodities, time frame, substitutes, and impact on pricing and profit.
What is Elasticity of Demand?
Demand elasticity refers to how a product’s demand reacts to a change in price. The higher the changes in product demand due to slight changes in price, the more elastic is the commodity. To calculate the price elasticity of demand, we need to divide the percentage change in quantity demanded by the percentage change in price:
Price Elasticity of Demand = Percentage change in quantity / Percentage change in price
Furthermore, in this case, if the price of a product increases, consumers may stop or reduce the purchase of the good or switch to another alternative available in the market. Typically, people also wait until the prices of the commodity go back to normal. However, price drops lead to people buying in higher quantities, but also bring in more new customers.
Using this formula for price elasticity of demand helps organisations determine the nature of their products. Moreover, it also allows you to set an effective pricing strategy as well as estimate the weight of the price in purchase choices.
What is Inelasticity of Demand?
As opposed to elasticity, when the demand for a commodity remains unresponsive to price changes, the product is known to have inelastic demand. Typically, inelastic products fall under necessities and don’t have acceptable alternatives. That is, people don’t have any other choice that resembles the product whose prices have increased. Hence, they continue buying these products in spite of price rises.
2. Types of Commodities
Necessities, such as food and medical care, salt, and water tend to have inelastic demand. Moreover, products that induce addiction like prescription drugs, alcohol, gasoline, cigarettes, etc., also have inelastic demand.
On the other hand, luxury products like luxury vehicles, designer clothing brands, electronics, and appliances, tend to have elastic demand. Typically, people tend to delay their purchases if the prices of luxury goods rise up. And when the prices reduce, the quantity purchased increases and also attracts new customers.
Therefore, in price elastic demand, the goods are considered a luxury, meaning that consumers can find cheaper alternatives and easily do without them. However, in the case of inelastic demand, the product or commodity is a necessity, people have fewer alternatives to pivot to and hence stick to the same product regardless of their price increase.
3. Substitute Product Availability
One of the factors that affect elasticity along with the price is the availability of substitute products. When there are multiple substitutes for an item or service, demand is more likely to be elastic. This happens as people can switch to a different product if the price of the original product increases.
Conversely, when there are few substitutes for a good or service, demand is more likely to be inelastic, as consumers have fewer options if the price of the original product increases. As discussed earlier, such products are necessities that people will continue purchasing.
4. Time frame
Another aspect of elasticity vs inelastic demand is how quickly it responds after the price change. In price elastic demand, For an elastic product, demand responds relatively quickly to price changes, while the opposite is true for inelastic products.
Due to a lack of reliable substitutes, products that have inelastic demand are insensitive to price change. For example, if gasoline prices go up, the decrease in demand is insignificant. Likewise, due to the availability of substitutes, products that have elastic demand fluctuate dramatically with the price change.
5. Impact on Pricing and Profit
One of the most important aspects of elasticity vs inelasticity is how they impact pricing strategies and company profits. When demand is price elastic, an increase in price leads to a decrease in revenue. But, a decrease in price leads to an increase in sales volume and therefore, revenue. Conversely, when demand is inelastic, an increase in price leads to an increase in revenue, and vice versa during a price fall.
Likewise, the elasticity of demand can significantly impact a business's revenue generation and profit margin. Hence, the pricing strategy of the products needs to be dynamic to remain competitive in the market and not lose any opportunity to gain both profits and sales.
A product with inelastic demand allows a business to charge a higher price and increase its profit margin with a limited impact on units sold. However, for a product with elastic demand, a business needs to charge a lower price to boost sales volume and maintain a steady level of demand and profit. Also, this strategy helps enhance your price perception in the market.
How Price Elasticity helps Businesses Succeed
When businesses take elasticity-informed decisions spanning their complete product catalogue, they practice driving higher overall revenue and profit margins. But the problem lies in executing learning promptly. Understanding the market from macro to micro, the price changes, the amount of profit you want to maintain for each product, and implementing price changes across platforms take time with the regular processes with ERP systems and excel sheets.
To implement dynamic pricing as fast as the demand changes in the market, an AI-enabled pricing tool can save you valuable time and resources, and get you miles ahead of competitors. You can read more about how Symson finds the optimal product prices while considering your own business rules.
Do you want a free demo to try how SYMSON can help your business with margin improvement or pricing management? Do you want to learn more? Schedule a call with a consultant and book a 20 minute brainstorm session!