Elasticity of Demand Refers to

Elasticity of demand refers to the degree to which demand changes as a result of a change in price. Perfect elasticity would be a situation where a 1% drop in the price results in a 1% increase in demand. Most products exhibit imperfect elasticity. Some products are said to have low elasticity of demand whereby a substantial price increase is met with only a minor decrease in demand. Reverse elasticity of demand refers to a situation where a price increase is met by an increase in demand (Investopedia, 2009).

Knowing the price elasticity of demand is important because it can help the manager maximize profits. We must keep in mind that as the leader of a private sector company, we have an agency relationship whereby our primary duty is to enhance shareholder wealth (Friedman, 1970). For any business, there is a point along the demand curve at which profit is maximized. As leader, it is my duty to determine where this point is.

What I am interested in is the marginal revenue loss that will accrue with a raise in price. So long as the revenue lost from lost sales is less than the revenue gained from the increase in prices, marginal profit has increased. Prices should be increased to the point on the demand curve where marginal profit is at its highest (AmosWEB, 2009). Having an understanding of price or income elasticity of demand helps the firm to set its prices. It may also help to determine price floors as well.

In addition, strategy and marketing can be affected as well. What was once a sale price could become a new selling point; what was once thought too high for our product positioning could actually be our ideal price point. Understanding how your customers react to the moves that you make is an essential component of business success. All private sector leaders should be focused on finding the point on.