Elasticity of Demand – MBA Mondays with Darwin

by Darwin on January 3, 2011

Elasticity of Demand is more than just nerdy economics jargon.  There are some real-life applications and examples of price elasticity of demand that are worth learning about so you can be a better informed consumer, and in some cases, business owner.  So, we’ll cover this concept in this week’s edition of MBA Mondays where I share various concepts and theories from my MBA days.  I hope you like the series – check out all topics covered (MBA Mondays with Darwin) and subscribe to RSS so you don’t miss future editions!

Elasticity of Demand Definition

The classical definition of price elasticity of demand is the amount by which the demand for a good or service will change with said given price change. In essence, does price matter?  Depending on the situation, it matters much more in some cases than others.  This type of assessment is utilized by corporations everywhere and you, as a consumer, are subject to the whims of these assumptions and behaviors from your peers.  Everything from the pricing of iPads to vaccines in the developing world are subject to elasticity pricing assumptions.

Take a look at the example below.  As you can see, as you increase price on an inelastic curve, there’s very little impact to the quantity – it’s almost indifferent.  Meanwhile, for elastic pricing, there’s a substantial change to quantity as price is altered, indicating elastic products are much more sensitive to price changes.

The elasticity curve for a given good or service is a determinant of multiple factors.

  • Is it considered a luxury or a necessity?
  • Are there suitable substitutes or is this one of a kind?
  • Is it perishable or can it be used at any point in the future?
  • How “expensive” is the item considered in the context of overall bankroll or income?

Price Elasticity of Demand Examples – Real Life

  • Price Gouging/Life and Death – Consider the scenario where there’s been some sort of natural disaster; let’s say something akin to the earthquake in Haiti.  With the public water system shut down and any standing water contaminated with cholera, clean drinking water is at a premium.  In the absence of any international aide or other viable sources of water, an enterprising (and arguably, unethical) entity may sell bottled water from the US mainland at exorbitant prices.  This would be an example of a highly inelastic price scenario.  Whether the cost per bottle is $1 or $3, anyone with the money is going to pay the asking price for safe, clean drinking water.  We recently saw this during hurricane Katrina with a man selling generators who was summarily arrested for providing a service our incompetent federal government was incapable.  I made the case there that price gouging is good.  In any event, people were willing to pay 2X, 3X, whatever the guy was asking to get their hands on a generator since they had NO alternative.
  • Concert Tickets/Superbowl Tickets – These are also relatively inelastic, especially on the scalping market.  While venues will generally sell at a set price established in advance with both historical data and public outrage over gouging as a consideration, once these tickets are in the hands of enterprising purchasers, the free market takes over.  If you were a huge Saints fan, you probably would have paid for tickets to make the game whether the asking price was $500, $1000 or $1500 per ticket.  Chances are, unless the price was starting to greatly affect your personal finances, you were gonna make that damn game whatever it cost!
  • Generic Medications (in the US) – In the United States at least (the emerging markets DO place a great deal of value on “branded generics” due to concerns over quality and brand recognition), if your doctor prescribes a generic script for 1% cortisone cream, there are a dozen generic manufacturers making pretty much the same ointment.  Why would you pay a penny more to buy the Teva med over Mylan?  The products are generic equivalents, and as such, excluding other marketing/PBM/formulary issues, a typical consumer would just buy the least expensive tube.  A price increase would likely have a significant impact on demand.  This would be an example of a highly elastic demand.

Now that you understand a bit about the concept and pricing models for price elasticity of demand, you can understand why companies price items the way they do – and how that balance is viewed from their standpoint.  This may inform your decisions about whether you want to be an early adopter of new technology, whether you want to buy generic, or how you want to price a good or service you’re going to sell yourself as an entrepreneur.

What Are Some Price Elasticity Examples You’re Thinking About?

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