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by Laurus Nobilis
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Finance Management

Price Elasticity (E)

 

Supply and Demand

 


What is the Price Elasticity? What is the influence of the Price Elasticity on Supply and Demand?

 

Posted: Feb 2008


 

 

 

 

The one of the most basic theory of Economic concerning the definition of the product's "Natural Price" say that the price of the product is at the equilibrium point of Demand and Supply. The graph below explains:  

GRAPH: SUPPLY and DEMAND

I f the product increases the price, the consumers will be less ready to buy such a product and the purchased quantity in a specific period will decrease. On the other hand if the price decreases, this might stimulate consumers to buy more.  

 

Obviously the price sensitivity changes from product to product, from consumer to consumer, but also from one moment to another. The Price Elasticity influence should be kept in mind when the price increase is being planned.



Supply and Demand

If Demand is greater than Supply, than the price increases and vice versa.  On the other hand, if the Supply is greater than Demand, than the price decreases and vice versa. When the functions of Supply and Demand meet, the price is "agreed".   

Both Demand and Supply have their functions that represent the ratio between quantity and price of product. But this function or curve is not always the same. It depends from the type of the product, time, number of competitors, etc. Basically, the curve of Demand explains how much quantity the shoppers are prepared to pay for the product if the price changes.

This means that if the product increases the price, the consumers will be less ready to buy such a product and the purchased quantity in a specific period will decrease. On the other hand if the price decreases, this might stimulate consumers to buy more.

This is phenomenon is called the Price Elasticity and is expressed with formula:

           % Change in Volume

E = ---------------------------------

           % Change in Price

Price Elasticity

If the Volume is changing faster than the price increase, that is High Price Elasticity ( High Price Sensitivity ). This happens with products such as luxury items, traveling, etc. Since consumer can live without these products or services, they decrease purchasing in a rate that is grater than rate of price increase.

If the Volume is changing slower than the price increase, that is Low Price Elasticity ( Low Price Sensitivity ). This is typical for core products, necessities like fuel, electricity, food, etc. In some specific cases the Volume even does not change at all. This happen with the most basic products like is the bread, or addictions as for example are cigarettes.

GRAPH: PRICE ELASTICITY ( No, Low and High Elasticity )

Price Elasticity

Also, Price Elasticity for the same product can be different from one situation to another. Example; the consumer is shopping in the supermarket and is very carefully picking his 2 liters beverage, since the price of the same flavor but in different Brands is € 0.10. The next moment, after the shopping is finished and the consumers sits in the caffe and order the same beverage that costs more than 2 liter bottle, while he get only 0,25l bottle.

Obviously the price sensitivity changes from product to product, from consumer to consumer, but also from one moment to another. The Price Elasticity influence should be kept in mind when the price increase is being planned.  

Watch PRICE ELASTICITY OF DEMAND Video.

 

 

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