Demand is the volume of goods or services that buyers are willing to buy at current prices over a period of time. There is the following relationship between the demand for a product and its price: the higher the price, the fewer consumers want to buy it - and vice versa. This dependence is called the "law of demand."
However, it is not enough for economists and analysts to simply foresee how changes in current prices will affect demand . The degree of such a change is of great importance. The force with which the demand changes depending on various factors is called “demand elasticity”. There are several types of such elasticity: price, cross and income elasticity. Each type has its own characteristics.
Price elasticity shows how demand changes depending on price fluctuations, and is expressed through the coefficient of elasticity :
Ed = (ΔQ / Q): (ΔP / P), where
ΔQ / Q - change in the number of purchased goods,
ΔP / P - change in the value of this product.
Also, the elasticity of demand can be calculated in percentage terms:
Ed =% Q /% P, where
% Q - percentage increase or decrease in demand,
% P - percentage increase or decrease in price.
This coefficient shows how demand will change if the price of a product increases or decreases by 1%.
Cross elasticity, in turn, characterizes the level of dependence of demand for the first product, depending on fluctuations in the value of another. The formula for this indicator is as follows:
Eab = (ΔQa / Qa): (ΔPb / Pb), where
ΔQa / Qa - change in demand for the first product a,%;
ΔPb / Pb - change in the price of the second product b,%.
Income elasticity is similar to price elasticity, however, the value of income now acts as a factor affecting the level of demand.
Ei = (ΔQ / Q): (ΔI / I), where
ΔQ / Q - change in the number of goods sold,
ΔI / I - relative change in income.
Depending on the coefficient obtained, these types of elasticity are distinguished:
1. Ed = 0.
In this case, we have absolutely inelastic demand. Zero value of the coefficient means that price fluctuations do not affect the number of purchased goods. As a rule, these are irreplaceable medications, for example, insulin.
2. Ed <1.
If the obtained value is in the range from 0 to 1, then this means inelastic demand. Consequently, price increases will have little effect on sales. If the company decides to reduce the margin on goods with inelastic demand, then instead of the expected increase in sales, it will receive a decrease in revenue. An example of goods with inelastic demand is food, as well as essential goods.
3. Ed = 1.
With a single elasticity, a change in prices will not affect the amount of revenue. She in this case has a maximum size. An example is the demand for various transport services, which tends to change equally with fluctuations in fare.
4. Ed> 1.
Elastic demand, which significantly depends on price fluctuations. Firms that sell such products are advised to lower their product prices, as this will increase sales revenue.
5. Ed = ∞.
This means that the demand for this product is characterized by absolute elasticity. At stable prices, there is a periodic change in demand for these products. An example of such products are luxury goods.
Elastic and inelastic demand is influenced by various factors. The most important of these are the following:
• the number of substitutes for such a product. If the product has many good substitutes, then the elasticity will be high;
• the proportion of such a product in the buyer's income. The dependence is directly proportional: the higher the specific gravity, the higher the elasticity;
• the importance of the product to the consumer - whether the product is a luxury item or is it an everyday product. Of course, the demand for luxury goods is more elastic;
• time factor. The more time a customer has, the higher the elasticity.