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Price and demand elasticity

Anonymous A asked on Oct 15, 2018

Hi there!

I am having trouble with understanding price elasticity. First, is price and demand elasticity the same? Second, If you have low price elasticity, a change in price will have a small change in amount of customers. Does this mean that you can raise the prices a lot? And eventually, how much can you raise the prices (or how do you decide how much?) before you will lose too many customers? Similarly for high price elasticity, how do you decide how much it will make sense to lower the prices?

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Benjamin replied on Oct 15, 2018
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price and demand elasticity

Hi,

Tihs is basically a way to describe client's reaction to price change :

- high price elasticity means that client is going to highly respond to a price change > price increase, demand (in qtty) will go down, and the opposite if price decrease

- Low price elasticity means that client is not sensitive to price change > increase of price can be done safely without putting volumes at risk.


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Elias
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replied on Oct 15, 2018
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Hi Anonymous,

the problem is with imprecise wording.

Technically what the elasticity describes is the change of a given variable (say Demand) with an incremental change of a different variable (say Price).

Mathematically this would be the first derivative of the demand function with respect to Price. So if we were precise we would speak about "the elasticity of demand with respect to price"

Because obviously, there may be a ton of other variables in the demand function (say the weather, available income, competitor prices or whatnot). So you could also create many other demand elasticities.

Now, to further complicate matters, prices can be elastic as well - stock prices are almost perfectly elastic, the price of a 100$-bill is perfectly inelastic. Price could actually change as a function of demand (then you've got yourself a set of interdependent equations) or as a function of many other things (like raw material prices or competitor prices). Then you would speak about "the elasticity of price with respect to X".

Unfortunately, business lingo rarely has scientific precision, so usually when people talk about "demand elasticity" and "price elasticity" they mean the same thing. Even if actually, they are two different things.

And yes, you can use demand elasticities (or "price sensitivity", which is another term often used) to determine whether a price increase would be beneficial (the gain in revenue exceeds the loss in customers or quantities bought) or not (customers are very sensitive to price (high demand elasticity with regard to price).

And while we're at it, a few things to keep in mind:

  • The elasticity of demand is usually not linear. That's almost always an approximation
  • Demand elasticity usually depends on the direction of change - a price raise of 1% (or 1$) does not have the same effect as a price cut of the same magnitude
  • Demand elasticity is predictably irrational (read the book by that title, btw.) - a change from 9.99 to 10.00 will have a far greater effect than from 9.98 to 9.99. (Many more examples like this).

Hope this helps,

Elias

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