Why elasticity is important

In other words, when the price changes or consumer's incomes change, they will not change their buying habits. Inelastic products are necessities and, usually, do not have substitutes they can easily be replaced with. Since the quantity demanded is the same regardless of the price, the demand curve for a perfectly inelastic good is graphed out as a vertical line.

For businesses, there are many advantages to price inelasticity. For example, they have greater flexibility with prices because demand remains basically the same, even if prices increase or decrease. If the business raises its prices up or down, consumers' buying habits will remain mostly unchanged.

This can impact demand and total revenue for a business in a couple of different ways. First, a business may have less overall revenue. If the price for an inelastic good is decreased and the demand for that good does not increase, this would result in a decrease in revenue.

For this firm, there is no beneficial outcome in reducing the price of its goods. Second, a business may experience more overall revenue. If the price for an inelastic good is increased and the demand for that good stays the same, the total revenue will increase because the quantity demanded has not changed. Normally, a price increase does, in fact, lead to a decrease in quantity demanded even if it is small. So, businesses that deal with inelastic goods are generally able to increase their prices, sell a little less, and still make higher revenues.

They tend to be protected against economic downturns and better able to maximize profits. The most common goods with inelastic demand are utilities, prescription drugs, and tobacco products. In general, necessities and medical treatments tend to be inelastic, while luxury goods tend to be the most elastic. Another typical example is salt.

The human body requires a specific amount of salt per pound of body weight. Too much or too little salt could cause illness or even death, so the demand for it changes very little when price changes—salt has an elasticity quotient that is close to zero and a steep slope on a graph. While there are no perfectly inelastic goods , there are some goods that come pretty close. For example, people need gas to drive their cars.

Even if gas prices get higher, people may not be able to stop commuting to work, taking their kids to school, and driving to the store.

Thus, people will still purchase gas even at a higher price. The cross elasticity of demand measures the responsiveness in the quantity demanded of one good when the price for another good changes. Cross elasticity of demand can refer to substitute goods or complementary goods. When the price of one good increases, the demand for a substitute good will increase as consumers seek a substitute for the more expensive item. Conversely, when the price for a good increases, any items closely associated with it and necessary for its consumption referred to as complementary goods will also decrease.

The advertising elasticity of demand AED is a measure of a market's sensitivity to increases or decreases in advertising saturation. The elasticity of an advertising campaign is measured by its ability to generate new sales. Positive advertising elasticity means that an uptick in advertising leads to an increase in demand for the goods or services advertised.

A good advertising campaign will lead to a positive shift in demand for a good. In general, elasticity is a measure of a variable's sensitivity to a change in a different variable. Most often, elasticity refers to the change in demand when the price for a good or service changes. The four main types of elasticity of demand are price elasticity of demand, cross elasticity of demand, income elasticity of demand, and advertising elasticity of demand.

Elasticity is measured by the ratio of two percentages. For example, consider the price elasticity of demand. The price elasticity of demand is measured by calculating the ratio of the change in the quantity demanded to the change in the price. In other words, price elasticity is the ratio of a relative change in quantity demanded to a relative change in price.

But it can go the other way. This is not what companies tend to do in practice. Rather, they send out questionnaires, run focus groups, or perform small-scale experiments in certain markets, to give them a sense of what would happen if they changed their price. But they are closely related. Many managers assume they understand the full picture based on their experience pricing their products in the marketplace, that they know how consumers will respond to almost any price change, explains Avery.

But rarely have companies tested extreme price changes. More extreme changes in price may elicit significantly different consumer responses. Therefore, elasticity can often be an inexact calculation. When a good is inelastic, there is little change in the quantity of demand even with the change of the good's price. The change that is observed for an elastic good is an increase in demand when the price decreases and a decrease in demand when the price increases.

Elasticity also communicates important information to consumers. If the market price of an elastic good decreases, firms are likely to reduce the number of goods or services they are willing to supply. If the market price goes up, firms are likely to increase the number of goods they are willing to sell. This is important for consumers who need a product and are concerned with potential scarcity. Typically, goods that are elastic are either unnecessary goods or services or those for which competitors offer readily available substitute goods and services.

The airline industry is elastic because it is a competitive industry. If one airline decides to increase the price of its fares, consumers can use another airline, and the airline that increased its fares will see a decrease in the demand for its services. Meanwhile, gasoline is an example of a relatively inelastic good because many consumers have no choice but to buy fuel for their vehicles, regardless of the market price. Your Privacy Rights.

To change or withdraw your consent choices for Investopedia. At any time, you can update your settings through the "EU Privacy" link at the bottom of any page. These choices will be signaled globally to our partners and will not affect browsing data.

We and our partners process data to: Actively scan device characteristics for identification. I Accept Show Purposes. Your Money. Finally, perfectly elastic situations result when any change in y will result in no change in x. A special case known as unitary elasticity of demand occurs if total revenue stays the same when prices change. Economists compute several different elasticity measures, including the price elasticity of demand, the price elasticity of supply, and the income elasticity of demand.

Elasticity is typically defined in terms of changes in total revenue since that is of primary importance to managers, CEOs, and marketers. For managers, a key point in the discussions of demand is what happens when they raise prices for their products and services. It is important to know the extent to which a percentage increase in unit price will affect the demand for a product.

With elastic demand, total revenue will decrease if the price is raised. With inelastic demand, however, total revenue will increase if the price is raised. The possibility of raising prices and increasing dollar sales total revenue at the same time is very attractive to managers. This occurs only if the demand curve is inelastic. Here total revenue will increase if the price is raised, but total costs probably will not increase and, in fact, could go down.

Since profit is equal to total revenue minus total costs, profit will increase as price is increased when demand for a product is inelastic.