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Part II: Considering Which Side You’re On in the Decision-Making Process
Think of elasticity as a measure of flexibility. Elasticity tells you how flexible customers are to change. Generally, if customers are very flexible to a given change, they’re considered elastic. If customers aren’t very flexible to a change, they’re inelastic. As a general rule, you hope customers are inelastic. That way, when you increase price, they will still buy a lot of your product. But remember, general rules are just that — general. And there is a reason for the old saying, “The exception proves the rule.” Customers respond to many things, so focus on the things that are most important to them. The most important elasticity concepts describe how customers respond to changes in
✓ The good’s price ✓ Income ✓ The prices of other goods ✓ Advertising Managers typically control two of these factors: the good’s price and advertising. Sometimes managers at least partially control a third factor, the prices of other goods. For example, a movie theater manager controls the ticket’s price and the prices of concessions (although the manager doesn’t control the prices other theaters charge). Finally, managers can’t control the general level of customers’ income, but demand is often affected by whether the general income level is increasing, a period of prosperity, or decreasing, a recession. A recession decreases movie ticket sales.
Knowing the Price Elasticity of Demand: The Fundamental Trade-Off The price elasticity of demand measures the most important elasticity relationship — how much quantity demanded changes given a price change. In other words, the price elasticity of demand allows you to project how a price change impacts revenue. For example, if the price of movie tickets increases from $8 to $10, does quantity demanded decrease from 5,000 tickets per week to 4,500 or from 5,000 to 3,000? It really matters. In the first case, the movie theater’s revenue increases from $40,000 ($8 × 5,000) to $45,000 ($10 × 4,500). In the second case, the theater’s revenue decreases from $40,000 to $30,000 ($10 × 3,000). Before changing price, you need to know if the result will be similar to the first or second situation, and the price elasticity of demand tells you which it will be.
