The effect that demand has on price is often easy to see. If a lot of buyers are competing for a resource that is in short supply it has the effect of pushing up the price of this resource. When we talk about price elasticity of demand we are looking at the way that prices reach in regards to demand.
Price Elasticity in the Real World
Price elasticity is also concerned with the amount people will be willing to pay for a product. If somebody has a low income they may be only willing to pay less for a product than somebody with a higher income. The person with the low income could be described as having low price elasticity because they are limited in the amount of money they can spend. Alternatively the individual can be said to have high price elasticity because they can afford to spend a lot more money on a product.
An understanding of price elasticity can greatly help our understanding of how things happen in the real world. If there are many similar products available then increasing price of one brand will usually lead to a fall in demand. This is because consumers can see that they can get a similar product for a cheaper price. If the item has a unique place in the market then price elasticity can have a different effect. A good example of this is gasoline. Even when prices increase at the pump the demand will stay almost constant. This is because there are no alternatives and people feel that buying this fuel is a necessity. If a unique item isn’t a necessity then people may respond to a price increase by just not using it anymore.
The Importance of Price Elasticity
An understanding of price elasticity can be very important for anyone who intends to sell products. They will want to know what is likely to happen should they decide to increase or decrease the price for their goods. There are complex mathematical formulas that can allow good predictions of price elasticity and these can be very useful. If a manufacturer can see that by raising their prices they will earn more money it will be a good path to follow. So long as the profits from the price increase outweigh any drop in demand it will be a good move. In fact with some products a price increase can actually increase demand because it makes them appear more exclusive.
The manufacturer or seller will also want to know what will happen if they reduce their prices. If this were to lead to an increase in demand then it could be a very shrewd move. If price elasticity is high the company may be able to make a lot more money by reducing the amount they charge for their products. Alternatively if decreasing the price of products is unlikely to have much impact on demand the company will want to know this before they make such a move.