As you know, the income of any company, enterprise and private entrepreneur depends on many factors, but perhaps the most important of them is the sales volume of products sold. It largely depends on what the level of revenue and the amount of net profit will be. This factor, in turn, depends on how elastic the demand is, and on the chosen pricing strategy. On the one hand, the higher the cost of the goods, the less they will buy it. On the other hand, at low prices, revenue will be meager. What is the best pricing strategy for an entrepreneur? The answer lies in studying the dynamics of demand.
Elasticity in terms of economics
For the first time this problem was attended by such a world famous scientist as A. Marshall. It was he who introduced the indicator of elasticity, thanks to which it is easy to distinguish when demand is elastic and when not, and based on this, choose the most profitable trading strategy. What does this concept mean? Elasticity in economic theory means the ability of some variables to respond to changes that have occurred with other quantities, on which they directly depend. If we talk about demand, then it is primarily affected by the selling price.
Calculation of elasticity coefficient and plotting
We denote by ΔQ the percentage change in the value of sales, and by ΔP the corresponding change in the value of production. The desired coefficient of elasticity is nothing but the ratio of these two parameters, taken with the opposite sign: ε p D = - ΔQ / ΔP. In cases where this indicator exceeds unity, they say that demand is elastic. When he is smaller than her, it means the opposite. And if the coefficient obtained is equal to 1, it is considered that this demand is the demand of unit elasticity. The dependence of sales on price for clarity is often displayed on the coordinate axes. Usually, vertically, an increase in the cost of a unit of goods is noted, and horizontally - the volume of revenue.
The elastic demand graph is a straight line tilted down with its right end. An example is shown in the figure to the left.
Elastic Demand Factors
There are certain reasons that somehow affect the behavior of consumers and the volume of purchases they make. As for the elasticity of demand, the following factors can be distinguished:
- The amount of income. The smaller it is, the greater the role played by the value of the goods.
- Time factor. In the long run, demand is usually elastic, and if the offer is valid for a short time, then the price goes by the wayside.
- The presence of "substitute products." The more there are, the greater the role price plays.
- The proportion of this product in the budget of consumers. The higher it is, the more demand is elastic.
- Product quality. For luxury goods, as a rule, ε p D > 1, and for necessities, usually ε p D <1.
- Stock availability. The more products the buyer has managed to acquire, the more important the price is for him, and, accordingly, the elasticity of demand is higher.
- The width of the product category. For specialized products, demand is less elastic and vice versa.
Choosing a trading strategy
When demand is elastic, the best trading strategy for the firm is to lower prices. Such a policy ultimately maximizes net profit. If demand is inelastic, then the “skim cream” strategy is applied, i.e. increase in sales prices. When the calculations yield a result very close to or equal to unity, this means that the entrepreneur should look for other methods of increasing income. Manipulations with prices in this case will not yield anything.
