Price Elasticity and Inelasticity - what it all means.

 

The picture says it all. The total revenue for a product for example, is directly dependent on 2 factors.

a) Price per unit

b) Quantity Sold.

The sweet spot normally is where the Demand Curve (sloping downwards from Left to Right) and the Supply Curve (sloping Upwards from Left to Right) meets, and taking the 'Y' axis on the vertical would be the right Price and taking the 'X' axis on the horizontal would be the number of units sold AT THAT PRICE.

So, when would a product be deemed to be Price Elastic or Price Sensitive ?

PRICE ELASTICITY

It would be so, when for example, the item, lets call it a Kueh Lapis (multicolored desert) is first priced at $2.50 or at the top end of the green box. When the Kueh Lapis is sold at $2.50 and the demand is 35, then the total revenue would be as stated in the green zone or 35 x $2.5 equals to $87.5.

When the seller at the end of the day cant sell the remaining Kueh Lapis, and he reduces it to $2.0, there is a surge in orders or 55. Hence his revenue will then be $2.0 x 5.5 or $110.

The downside would be that he would need to make and sell more (55) for lower margin but the total revenue would be MORE than if he made less and sold them at a higher price.

Price Elasticity occurs when there are many other substitutes (many other snacks vying for my stomach when I need a pick me up, savory, sweet or just a bun), hence, people will buy more of this product when they deem it to be 'cheap' or inexpensive and can stretch their dollar to fill their stomachs.

Circumstances when price elasticity occurs :

a) many competitors and substitutes

b) small  price change and people are price sensitive. (daily necessities would be ideal catagories, such as toothpaste, toiletries, soaps, consumables, snacks,soft drinks and running shoes or sneakers are items which come to mind). 

This is PRICE ELASTICITY.

PRICE INELASTICITY

This would be when the product (say for example) petrol is priced first at $2.30 per litre, As there are very few other substitutes to petrol (once can downgrade the quality of his petrol, or else take public transport eschewing totally the need for his own transport but we are discussing the transportation function, say for a Grab Car Driver).

So hypothetically speaking at $2.30 per litre, the guy buys say 30 litres, and the total output he pays would then be $2.3 x 30 or $69.

If the price shoots up to $2.40, the poor guy still needs to fill up his tank, and so he skimps and tries to shorten his commute routes via Google Maps, he would still need close to 30 litres. So he is forced to buy 28 litres.

His overall outlay would then by $2.4 x 28 or $ 67.2

Price Inelasticity would occur when there is an oligopolisitic market (few players dominating the market such as petrol) and the item is deemed as a luxury item (branded handbags, designer shoes, petrol are 3 such products which come to mind). 

So which product technically is 'better' to sell ?  The one sold in price elastic market or the price inelastic one ?  The answer is "It Depends". 

Well, lets look at the cost or making these products.

a) For Kueh Lapis, say the cost of making one Kueh Lapis (time, ingredients, petrol to send to shop, rental, portion of business owner salary etc etc) is $1.00.

Then to sell 55 per day his margin would come to $55 daily. Working 6 days a week, that is 24 days per month, the gross margin from Kueh Lapis would be $1,320.

Of course, the seller would try to make as many different sweet desserts as he can in his stall, so this number above is totally meaningless. Unless  he can estimate the rest of his sweets and desserts he sells per day, can the owner then multiply the different margins he makes from the other desserts / sweets to see if his profit gained every month is worth his time, rent, and all the other fixed and variable expenses spent.

The same goes for the Petrol Station, as these are giant multi layered and multi country business entities which have been operating profitably for decades, making billions each year.

The bottom line is this :  If you want to go into business, choose one which has few competitors, and stick to price inelastic market places where you have a distinct advantage in your value add (whatever it is) and serve that small niche quietly.