Price elasticity of demand for a product or service is a measure of how much the quantity demanded changes as a result of a change in price. Very inelastic products would show little change in demand when prices are increased. Elastic products would have a significant change. For a small-business owner, understanding price elasticity is critical to making strategically sound pricing decisions. If he increases the price of a highly elastic product, the quantity purchased may decline so much that total revenues from the product decline -- not the result he intended.
If consumers can easily find a product to substitute for the one that has an increased price, demand for the product will be highly elastic. For example, specific brands and makes of automobiles are highly elastic because consumers shopping for automobiles have a myriad of brand and model choices.
Products whose purchase prices represent a significant portion of a consumer’s overall budget tend to be price elastic. Household appliances and recreational products such as motor boats fall into this category. A 10-percent difference in the price of two brands of refrigerators can sway a consumer to purchase the less expensive brand.
A consumer may view staple foods, such as vegetables, as necessities for a balanced diet, so will continue to purchase them at the grocery store even if prices rise. Conversely, dining out at restaurants would be viewed as a luxury. If a family’s favorite restaurant raises prices, the family could elect to eat more meals at home, or find a less expensive place to dine out.
Brand name food products are elastic because savvy consumers know how to compare prices at more than one grocery store. Grocery retailers actively compete against each other to be regarded as the low-price leader in their market. Brand name goods sold in mass merchandise stores are also elastic. Consumers know to look for their favorite brands of consumer electronics, for example, at more than one retailer, and seek out the lowest price.
The decision to purchase airline tickets can be unrelated to price -- highly inelastic -- if a traveler absolutely has to get to a certain destination on a certain date. If the individual’s travel plans are more flexible, it gives him time to shop for the lowest-priced tickets he can find, making the same product now price elastic.
Professional sports leagues often raise the prices of tickets to their events. One season ticket holder may not hesitate to renew his tickets at a higher price, because attending the games is an important -- perhaps indispensable -- activity in his life. The tickets in this case would be highly inelastic. Another sports fan might view having to pay more for the same experience as totally unacceptable -- the tickets are highly price elastic to him.