Is there elastic demand in your business?

When in business you should never rest on your marketing decisions. You should continually use market research and your own judgment to determine if your marketing decisions need to be adjusted.

You can use elasticity to determine what products or services you can raise prices on and what prices should have lower prices. If a product or service has elastic demand, it means your customers buy it even if it costs more, but if demand is not very elastic, your customers might skip buying the product or buy it from a competing merchant. Elasticity of supply affects your revenue; more competitors selling your product can reduce your income.

When it comes to adjusting price, you should consider what effect supply and demand and a change in price is likely to have on your target market demand for your product or service. Supply and demand is perhaps one of the most fundamental concepts of economics and its the backbone of a market economy.

Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship.

Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price. The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship.

Price is a reflection of supply and demand. These laws don't capture everything that economists would like to know about the supply and demand model, so they developed quantitative measurements such as elasticity to provide more detail about market behaviour.

We use elasticity when we want to see how one thing changes when we change something else. How does demand for a good change when we change its price? How does the demand for a good change when the price of a substitute good changes? These are the type of questions that elasticities help us answer.

Factors that affect supply and demand

Typically, if prices fall sharply, demand will increase because more customers will be willing or able to purchase the product. Similarly, if the supply of a product or service is dwindling, the price rises; whereas if there is an excess of a product or service, the price falls because there are plenty of suppliers to meet the demand. Factors that affect supply and demand include

• Location - distance to nearest competitor and convenience, parking

• Alternatives - competitors and pricing, service

• Product or Service - quality, exclusivity, availability, uniqueness, choices, service levels

• Customer types - earnings, employed, unemployed, working hours, family or singles

Rubber band equation

Elasticity refers to the degree to which the demand and supply curves react to changes in price. Using the analogy of a change in price - its like the force applied to a rubber band. The change in 'quantity demanded' is how much the rubber band stretches. If the rubber band is very elastic, the rubber band will stretch a lot, and if it's very inelastic, it won't stretch very much. When expressed as an equation, elasticity equals % change in quantity / % change in price. This means that highly elastic goods and services will see significant changes in demand or supply with very small changes in price.

Market changes

Elasticity is evaluated on the assumption that, all things being equal, no other changes will be made and only price is adjusted. The logic is to see how price by itself will affect your overall demand. Obviously, the chance of nothing else changing in the market but the price of one product is often unrealistic. For example, your competitors may react to your price change by changing the price on their product. Despite this, elasticity analysis does serve as a useful tool for estimating market reaction.

Necessities vs Luxuries

Necessities tend to have a more inelastic demand curve, whereas luxury goods and services tend to be more elastic. For example, the demand for a five star hotel room or restaurant is more elastic than the demand for food, power, water and gas. The more necessary a good is, the lower the price elasticity of demand, as people will attempt to buy it no matter the price.

Revenue

The important issue with elasticity of demand is to understand how it impacts your business revenue. In general the following scenarios apply to making price changes for a given type of market demand

• For Elastic Markets – increasing price lowers total revenue while decreasing price increases total revenue

• For Inelastic Markets – increasing price raises total revenue while decreasing price lowers total revenue

• For Unitary Markets – there is no change in revenue when price is changed

It’s important to conduct regular supply and demand analyses in order to understand changes that have occurred to the supply and demand of your product or service. Regularly analyse your sales numbers and see if you have surplus supply or a shortage, and adjust your orders appropriately.

Analysing supply and demand will lead you to a better understanding of your market and the needs of your customers, helping you find an equilibrium price for your product or service. Failure to properly analyse supply and demand could leave you with a product, service, surplus or shortage, or it could cause you to price your product, service incorrectly. The Business Minder is a business consulting analyst and management service operating in SE Asia with clients in Bali, Indonesia, Malaysia and Singapore.