The first law of the economy states that betweenthe demand for the goods and the price for it is inversely related. However, this is too general a statement. For economists it is equally important to measure the degree of reaction of consumers to a changing price, because in different markets with the same change in the cost of goods, the quantity that the consumer wants to buy varies in different ways.
The concept of price elasticity
To measure the sensitivity of demand or reactionchange in the magnitude of demand for a change in the value of goods used indicator, which is called "price elasticity." In other words, elasticity is the ratio of the percentage change in demand to the percentage change in the value of the product.
The quantitative measure is called"coefficient of elasticity," which makes it clear how much the demand will change by a percentage after the price of the commodity changes by one percent. In connection with the presence of an inverse relationship between the value of the goods and the demand for it, the elasticity coefficient always assumes a value less than zero. However, for comparison purposes, economists neglect using the absolute value of the coefficient.
Interpretation of the coefficient of elasticity
The value that the priceelasticity in each individual case, allows to judge economists about the degree of elasticity of demand for the studied product. Depending on this, the following product groups are distinguished:
- Goods, the demand for which is elastic. They have a coefficient of elasticity greater than one. In this case, there is a sensitive reaction of buyers to the change in the value of goods, as a result of which demand changes more than cost. In such a situation, a change in the value of a commodity entails a change in the total revenue from its sale in the opposite direction.
- Goods with inelastic demand. Price elasticity, calculated for them, takes a value less than one. In the event of a reduction in the price of goods with inelastic demand, an increase in demand is not enough to compensate for the fallen revenue, as a result, after the price, sales revenue falls.
- Goods whose price elasticity is equal to one. The price and magnitude of demand in this case change in the same way, as a result, neither a decrease nor an increase in value does not change the sales proceeds.
Methods for calculating elasticity
The elasticity coefficient can be calculated in two ways:
- When calculating arc elasticity, two points are taken into account, between which the value of elasticity is measured.
- Point elasticity of demand for pricerepresents the change in the magnitude of demand with an infinitesimal change in price. The fact is that the demand curve has a convex shape. All this leads to the fact that the price elasticity at each point of the graph takes different values.
The definition of price elasticity sometimes causesdifficulties in understanding, but without this there is no need for a single company. In the process of making decisions about price policy, organizations should be guided by the elasticity of demand for the goods, so that the change in revenue following the change in value does not become unexpected.