As you know, the income of any firm, enterprise and private entrepreneur depends on many factors, but perhaps the most important of them is the volume of sales of products sold. It largely depends on its size, what will be the level of revenue and the amount of net profit. This factor, in turn, depends on how elastic demand is and on the chosen pricing strategy. On the one hand, the higher the cost of a product, the less people will buy it. On the other hand, at low prices and revenue will be miserable. What is the best pricing strategy for an entrepreneur? The answer lies in studying the dynamics of demand.
For the first time, such a world-famous scientist as A. Marshall took care of this problem. It was he who introduced the indicator of elasticity, thanks to which one can easily distinguish when demand is elastic and when it is not, and on the basis of this, choose the most profitable trading strategy. Whatwhat does this concept mean? Elasticity in economic theory means the ability of some variables to respond to changes that have occurred with other quantities on which they directly depend. If we talk about demand, then it is primarily affected by the selling price.
Calculation of the coefficient of elasticity and plotting
Denote by ΔQ the percentage change in sales volume, and by ΔP the corresponding change in the cost of production. The desired elasticity coefficient is nothing but the ratio of these two parameters, taken with the opposite sign: εрD =- ΔQ/ ΔP. When this indicator exceeds one, demand is said to be elastic. When it is smaller than her, it means the opposite. And if the resulting coefficient turns out to be equal to 1, it is customary to assume that this demand is a demand of unit elasticity. For clarity, the dependence of sales on price is often displayed on coordinate axes. Usually, the increase in the cost of a unit of goods is marked vertically, and the amount of revenue is marked horizontally.
A graph of elastic demand is a straight line with its right end down. An example is shown in the figure on the left.
Factors of elastic demand
There are certain reasons that in one way or another affect the behavior of consumers and the volume of purchases they make. With regard to the elasticity of demand, the following factors can be distinguished:
- The amount of income. The smaller it is, thethe cost of goods plays a big role.
- The time factor. In the long run, demand is usually elastic, and if the offer is valid for a short time, then the price goes by the wayside.
- Availability of "substitute products". The more there are, the more important the price is.
- The share of this product in the budget of consumers. The higher it is, the more elastic the demand.
- Product quality. For luxury goods, as a rule, εrD >1, and for necessities, usually εr D < 1.
- Stock available. The more products the buyer managed to purchase, the more important the price is for him, and, accordingly, the elasticity of demand is higher.
- The width of the product category. For specialized products, demand is less elastic and vice versa.
Choosing a trading strategy
When demand is elastic, the best trading strategy for a firm is to cut prices. Such a policy ultimately maximizes net profit. If demand is inelastic, then the cream skimming strategy is applied, i.e. increase in sales prices of products. When the calculations give a result very close or equal to one, this means that the entrepreneur should look for other methods to increase income. Manipulations with prices in this case will give absolutely nothing.