Price elasticity of demand and supply

Price Elasticity Question: How can we use the concept of price elasticity to identify our closest competitors?

By definition, price elasticity is defined by the percentage change in product demand given a percentage change in price. Products or services are considered to be inelastic when the demand for a product is proportionally smaller than the change in price. Conversely, a product or service is considered elastic when the demand for a product or service is proportionally greater than the percentage change in price. When products are highly elastic, demand for them changes quickly in response to price changes. Likewise, highly inelastic products or services appear to be immune to price changes. This concept of price elasticity has major implications on identifying the closest competitors a company has for several reasons. First, products that have comparable elasticity are often substitutes for one another, and often are direct competitors as a result. An example of this is how Wal-Mart analyzes price elasticity of their top 100 toy products during the holiday months versus Toys' R Us pricing. Wal- Mart realizes that if they can price their top 100 toys precisely on their respective demand curves, they will be able to have a significant price elasticity advantage over Toy's R Us. This level of analytics has been accomplished by Wal-Mart during the last few holiday seasons, using this knowledge as a basis for initiating price wars in the toy segment (USA Today, 2004). Second, it's possible to use price elasticity as an indicator of a product or services' level of necessity or luxury, the proportion of income required to purchase the item, and the time period covered for the purchase all indicate highly elastic products. Inelastic products often have many substitutes, are more commodity-like, and are sold through bundling, convenience offers and drastic discounting. Price elasticity then can be used to define competitors not only by designating which products are potential substitutes, but also by the percentage of a persons' income needed to complete the purchase and the time horizon of the purchase. Most important of all, pricing elasticity indicates which strategies competitors will take at the exclusion of price. This can be insightful to see how a competitor in an inelastic market will rely on promotional strategies, product bundling, new distribution arrangements, and also even entirely next generation products to compete. Pricing elasticity then can indicate not only which the most dominant competitors are, but also what their likely competitive strategies will be depending on the relative elasticity of the markets they are competing in.