What is the difference between elasticity and inelasticity of demand?
12/13/2022 - Price optimization
The elasticity of demand is an indicator that makes it possible to measure how demand for a product or service varies when its selling price changes. It allows you to check and predict how consumers will behave should prices rise or fall. This variable makes it possible to define if demand will be elastic or inelastic — a key factor when setting prices in your e-commerce business. We explain the differences between the two types of demand so that you can optimize your brand’s profits.
- Elastic demand occurs when price changes affect the level of demand. This behaviour is typical of the most price-sensitive consumers. They will stop buying certain products if the price rises or falls beyond what they deem normal. The products that respond to this type of demand, known as elastic goods, tend to have substitutes at more competitive prices on the market.
- Inelasticity of demand: When demand remains constant no matter what price changes occur, demand is inelastic, or there is an inelasticity of demand. Inelastic products are usually staple goods that do not have substitutes with the same characteristics or that are as well thought of by consumers. This group tends to include food, healthcare products, or the textbook cases: tobacco or fuel.
As you can see, whether substitute goods are available on the market largely conditions the elasticity or inelasticity of demand. Consumers are less likely to put up with a price rise when they have alternatives. That is why it is crucial to know the behaviour of your buyer personas, your competitors’ prices and their product catalogues. This will help you make better decisions about amending your pricing policy and will avoid a potential fall in demand.
How do you calculate whether demand is elastic or inelastic?
To calculate the elasticity of demand, divide the percentage change in demand by the percentage change in price. The result will always be more or less than one.
- When the value is more than one, demand is elastic and will change as prices change.
- When the value is less than one, demand is inelastic, and consumers are more loyal to the brand, or less price-sensitive.
Very occasionally, the elasticity of demand is one. This means that it is proportional, will not vary much, and will be in line with price changes. However, it is extremely rare and applies to very few products.
How to react to changes in demand
Setting prices in line with the elasticity of demand can be tricky without detailed information about the market and consumers. For example, when, like now, there is inflation, e-commerces tend to increase prices to compensate for increased costs — even at the expense of reduced demand. This situation is not sustainable in the medium and long term.
An agile and efficient way to adapt to changes in the market would be to use a dynamic pricing tool. These automated tools recommend the most competitive prices for any product at any moment. This software collects millions of data about competitors’ pricing and catalogues. Then using bespoke variables, like expected conversions or profit margin, it determines the optimal price for the e-commerce’s profitability.
Category: Price optimization
