Elasticity of Demand

Topics: Price elasticity of demand, Supply and demand, Elasticity Pages: 5 (1730 words) Published: April 22, 2013
Elasticity of demand measures the responsiveness of the quantity of demand to changes in any of the variables which may affect demand, assuming ceteris paribus. However, as there are a lot of different products in the world, all of them have their own circumstances, depending on which they may have either elastic or inelastic demand. Knowing the PED will allow us to make decisions on the following, and therefore, be able to run a successful business. That’s why in different circumstances companies use either high or low price strategies.

Apple remains a leader in innovations that are adored by consumers around the world. The brand helped the company to generate $40 billion in profits over the past 12-months, the second most in the world behind Exxon Mobil. Apple products are famous all over the world. It is a classic mobile, computer & software brand. As we can see on the diagram below, it has a very inelastic demand, assuming ceteris paribus, as if the prices increase significantly, the quantity of demand will fall slightly.

Graph 1: Inelastic Demand curve

Analysis of the diagram:

The original price of an apple product is 500 pounds. The original quantity of demand is 10,000. The price increases by 20%, from 500 pounds to 600 pounds. After it the quantity of demand falls by 5%. Now the quantity of demand is 9,500. PED equals to percentage change in the price divided by percentage change of the quantity of demand. So, PED = = - ½ (inelastic demand). The Original Sales Revenue equals to price multiplied by the quantity of demand: 500£ × 10,000 = 5,000,000£. After increasing the price, the Final Sales Revenue becomes: new price × new quantity of demand = 600£ × 9500 = 5,700,000£. The revenue gain is now: FSR-ORS = 5,700,000£ - 5,000,000£ = 700,000£. You can also see the revenue gain is larger than the revenue loss (as drawn on the diagram).

High price strategy will especially work, when Apple releases its new long-awaited product, which is advertised all over the world. For example, with four days to go before the iPhone 5 becomes available, customers have begun lining up outside Apple's flagship Fifth Avenue store in New York City in what has become an annual tradition, as you can see it on the photo. Obviously, the price is absolutely unimportant for most of them. These customers are usually Apple fans, who won’t switch to another brand, but buy this product, even if the corporation pushes the price up by 20%.

Besides, most Apple customers belong to socio-economic groups A and B. So, they spend a small percentage of their income on a good. When the price increases even by 20%, this will have very little effect on their real income. Moreover, customers buy Apple goods infrequently (nearly once a year), and even when the price increases, their purchasing power will fall insignificantly. Therefore, the quantity of demand will fall slightly, something like by 5%. Therefore, price elasticity of demand will be inelastic.

Apple firm can certainly exploit the inelastic demand by increasing the price because of an economic boom, because more people will be able to buy luxury Apple products. Customers will choose Apple because of a low competition, as this corporation provides a very high quality, as well as status and exclusivity. Apple products are classic status, or even icon products. Their prices can significantly grow up, but the quantity of demand will decrease only slightly, because people will be still buying its goods.

However, we need to assume that ceteris paribus doesn’t exist in reality, therefore, other factors, such as taste, income and prices of other products, may change. That may also affect the quantity of demand and not all customers will react in the same way. Therefore, if Apple increases their prices by 20%, they may gain or lose customers and revenue depending on their individual reactions. Actually, the high price strategy might not work, and therefore, the demand...
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