Businesses need to understand how responsive customers are to changes in price and income. Elasticity data provides critical insights for making effective marketing decisions across pricing, targeting, and product strategy.
Price Elasticity of Demand (PED)
Definition:
Price Elasticity of Demand (PED) is a measure of how much the quantity demanded of a product changes in response to a change in its price. It helps businesses understand how sensitive consumers are to price changes, enabling better-informed pricing strategies.
Formula (for understanding, not calculation):
PED = Percentage change in quantity demanded ÷ Percentage change in price
Interpretation of PED values:
PED > 1 (Price Elastic):
Demand is sensitive to price changes. A small change in price results in a proportionally larger change in quantity demanded.
Example: Designer handbags, mobile phones during sales events, or non-essential consumer goods.
PED < 1 (Price Inelastic):
Demand is relatively insensitive to price changes. A change in price results in a proportionally smaller change in quantity demanded.
Example: Petrol, cigarettes, basic utilities (electricity, water), and essential groceries.
PED = 1 (Unitary Elastic):
A percentage change in price results in an equal percentage change in quantity demanded. Revenue remains constant.
PED = 0 (Perfectly Inelastic):
Demand does not change at all with price. Consumers will buy the same amount regardless of price.
Example: Life-saving medication such as insulin.
PED = ∞ (Perfectly Elastic):
Even a tiny increase in price will cause demand to fall to zero. This is rare in practice but may be found in markets with perfect substitutes.
Factors influencing PED:
Availability of substitutes: The more substitutes available, the more elastic demand is.
Necessity vs luxury: Necessities tend to be inelastic, luxuries more elastic.
Time period: Demand tends to be more elastic in the long run as consumers can change behaviour.
Brand loyalty: Strong brands may make demand more inelastic.
Diagram: Elastic vs Inelastic Demand Curves
While diagrams are visual tools, students should be familiar with how they look and what they represent:
Elastic demand curve: Flatter in shape. A slight change in price causes a large change in quantity demanded.
Inelastic demand curve: Steeper in shape. A change in price results in a relatively small change in quantity demanded.
In both cases:
The vertical axis represents price.
The horizontal axis represents quantity demanded.
These curves help businesses visualise the potential effects of changing price on quantity sold.
Income Elasticity of Demand (YED)
Definition:
Income Elasticity of Demand (YED) measures how the quantity demanded of a good changes when consumer income changes. It is used to classify products as normal or inferior and to determine how demand may shift during economic growth or recession.
Formula (for understanding):
YED = Percentage change in quantity demanded ÷ Percentage change in income
Interpretation of YED values:
YED > 1 (Income Elastic, Luxury Goods):
As income rises, demand increases more than proportionally.
Example: High-end electronics, overseas holidays, designer clothing.
YED between 0 and 1 (Income Inelastic, Necessities):
Demand increases with income but at a slower rate.
Example: Bread, milk, fuel.
YED < 0 (Negative Income Elasticity, Inferior Goods):
As income increases, demand decreases. Consumers switch to higher-quality alternatives.
Example: Instant noodles, bus travel (when compared to car ownership).
Using YED:
Helps businesses forecast demand under different economic conditions.
Assists in product portfolio planning by identifying products that will perform better in economic booms or downturns.
Supports pricing and promotional decisions by identifying which income groups are likely to be affected by changes in the economy.
Interpreting Elasticity Data in Context
At A-Level, students are not required to calculate elasticity values but must be able to interpret them correctly when presented in case studies or data tables. This involves understanding how PED and YED values influence revenue and strategy decisions.
PED and Total Revenue
Understanding the relationship:
Elastic demand (PED > 1):
Price ↑ → Quantity demanded ↓ more → Revenue ↓
Price ↓ → Quantity demanded ↑ more → Revenue ↑
Inelastic demand (PED < 1):
Price ↑ → Quantity demanded ↓ slightly → Revenue ↑
Price ↓ → Quantity demanded ↑ slightly → Revenue ↓
Application example:
A cinema finds that its ticket sales are price elastic. If it increases ticket prices from £10 to £12, the number of visitors drops significantly, reducing overall revenue. In contrast, lowering prices attracts more visitors and increases total takings from tickets and concessions.
YED and Market Strategy
Income elasticity allows businesses to assess how different income levels affect demand:
High YED products: Suited for premium markets; promote during economic growth.
Low or negative YED products: Useful in recessions or when targeting price-sensitive consumers.
Example:
During economic recovery, car dealerships may focus on promoting electric vehicles (a high YED good), whereas budget airlines may see less demand as consumers opt for more comfortable or flexible travel options.
Application to Marketing Strategy
Elasticity data has direct implications for the four Ps of the marketing mix — particularly pricing, product, and promotion.
Pricing Decisions
Elastic demand:
Price reductions can significantly increase sales and revenue. Discounts, offers, and dynamic pricing are often used to drive demand.
Inelastic demand:
Businesses may raise prices without losing many customers. This is common in markets for petrol, public transport, or branded medicines.
Strategic implication:
Understanding PED helps avoid pricing mistakes. If demand is elastic and a business raises prices, it risks a sharp drop in sales and revenue.
Product Mix Decisions
Firms use elasticity to plan product ranges that appeal to customers with different income and price sensitivity levels:
Elastic products:
Compete on value, quality, or features. Price wars may be common.Inelastic products:
Provide an opportunity for stable or premium pricing, focusing on brand strength and customer loyalty.High YED goods:
Add luxury product lines or upsell features during economic expansion.Negative YED goods:
Useful in discount retail and developing markets.
Example:
A supermarket offers both premium and budget ranges. When the economy is growing, it promotes its high-YED organic product range. During downturns, it highlights its value-brand goods.
Targeting and Market Segmentation
Elasticity helps define and reach appropriate customer segments:
Price-sensitive customers (elastic demand):
Use competitive pricing, value messaging, and discount campaigns
Brand-loyal customers (inelastic demand):
Focus on emotional appeal, quality assurance, and consistent servic
Income-segmented targeting (based on YED):
Offer products at varying price points, such as car manufacturers offering budget and luxury models under different brand names.
Example:
A mobile network operator targets students with price-sensitive, elastic tariffs, while offering premium plans to business users with inelastic demand.
Promotion and Messaging
Elasticity also influences promotional strategy:
Elastic demand:
Promotions and discounts are effective in driving volume.
Inelastic demand:
Emphasise reliability, trust, or urgency over price.
Luxury products with high YED:
Use aspirational advertising to appeal to affluent segments.
Inferior goods:
Highlight affordability and practicality rather than prestige.
Example:
A luxury watch brand doesn’t run discount sales but instead focuses on exclusivity and craftsmanship to maintain an inelastic demand profile. In contrast, supermarkets often use price cuts and loyalty offers to attract price-sensitive consumers.
Elasticity and Competitive Advantage
Understanding PED and YED gives firms an edge in both strategic and day-to-day decisions.
Anticipating Competitor Moves:
In elastic markets, firms monitor each other’s pricing closely to avoid losing market share.
Reducing Elasticity:
Businesses aim to reduce price elasticity by building brand loyalty, offering superior service, or differentiating their products.
Elasticity and Innovation:
Firms may create inelastic demand through product innovation, patents, or exclusive content. This allows more flexibility in pricing and greater profit margins.
Example:
Apple uses branding and product differentiation to create relatively inelastic demand for its devices, allowing it to maintain premium pricing compared to competitors.
Interpreting Graphs and Data in Exams
Students must demonstrate they can:
Identify demand as elastic, inelastic, or unitary based on PED values.
Describe how price changes will affect revenue.
Analyse real-life scenarios where elasticity impacts decision-making.
Apply elasticity concepts to written data, graphs, or case studies.
Sample interpretation:
A business has the following data:
PED for sunglasses: 2.1 (elastic)
PED for bottled water: 0.3 (inelastic)
If prices are raised:
Sunglasses: Sales will fall significantly, revenue will likely fall.
Bottled water: Sales will decrease slightly, revenue may increase.
Recap of Key Terms
Price Elasticity of Demand (PED): Sensitivity of demand to price changes.
Income Elasticity of Demand (YED): Sensitivity of demand to income changes.
Elastic Demand (PED > 1): Consumers are very responsive to price changes.
Inelastic Demand (PED < 1): Consumers are less responsive to price changes.
Normal Goods (YED > 0): Demand rises with income.
Luxury Goods (YED > 1): Demand rises more than proportionally with income.
Inferior Goods (YED < 0): Demand falls as income rises.
FAQ
Yes, the price elasticity of demand for the same product can vary between markets and over time due to differences in consumer preferences, income levels, availability of substitutes, and cultural factors. For example, bottled water may be inelastic in a hot country where it’s essential but elastic in a region with easy access to free tap water. Over time, elasticity may also change if new substitutes appear or if a product becomes more of a necessity due to trends or lifestyle changes.
Businesses aim to reduce price elasticity to gain more pricing power. They do this by building strong brand loyalty, offering unique features or added value, improving product quality, creating emotional connections through advertising, and establishing high switching costs. These tactics reduce the likelihood that consumers will respond to price increases by switching to alternatives, allowing firms to charge premium prices without losing significant sales volume. Patent protection and exclusive designs can also help reduce elasticity.
PED influences how successful a price-based promotional campaign will be. For elastic products, price reductions during promotions can significantly boost sales volume and overall revenue. However, for inelastic products, promotions may not yield a substantial increase in quantity sold and could even reduce revenue. Firms must consider elasticity before running discounts, as cutting prices on inelastic goods may erode profit without driving sales. Understanding PED ensures that promotional spending is targeted towards products with the highest responsiveness.
When launching a new product, elasticity data helps firms forecast demand responses to price or income levels and select the right initial pricing strategy. If research suggests demand is elastic, a low introductory price might attract more customers and encourage trial purchases. In contrast, if demand is inelastic, the business could set a higher price to recoup development costs without losing many buyers. Estimating YED also guides firms in targeting income segments, helping them tailor features and promotional messages accordingly.
Elasticity directly affects pricing power, which in turn impacts profit margins. When demand is inelastic, firms can raise prices with minimal impact on sales volume, leading to higher margins. If demand is elastic, raising prices may reduce sales significantly, harming revenue and profit. Businesses with more inelastic demand benefit from greater flexibility to adjust prices without needing to cut costs or expand output. Therefore, reducing elasticity through branding or product differentiation can be a long-term strategy to improve profitability.
Practice Questions
Analyse how knowledge of price elasticity of demand (PED) can help a business make effective pricing decisions.
Understanding PED allows businesses to anticipate how changes in price will affect sales and revenue. If demand is price elastic (PED > 1), lowering prices can increase total revenue as customers are responsive to price changes. Conversely, for price inelastic products (PED < 1), raising prices can increase revenue since demand falls only slightly. This insight helps firms set prices strategically to maximise revenue, avoid price cuts that harm profit, or raise prices without losing customers. It also enables differentiation strategies that make demand more inelastic through branding or improved service.
Explain how income elasticity of demand (YED) can influence a firm’s marketing strategy during an economic downturn.
Income elasticity helps businesses identify which products are likely to experience a change in demand when consumer incomes fall. During a downturn, demand for normal or luxury goods (positive YED) may decrease, while demand for inferior goods (negative YED) could rise. Firms can adjust their marketing by promoting lower-cost alternatives, introducing value product lines, or increasing advertising on budget brands. For example, supermarkets may highlight own-brand items to attract cost-conscious customers. By aligning products and promotions with income trends, firms can maintain sales and better meet consumer needs during economic challenges.
