Price Elasticity of Demand: Video Game Consoles

Introduction to Price Elasticity

Price elasticity refers to the degree of responsiveness of consumers and suppliers to price changes — specifically, the degree to which the demand or supply of a good or service is affected by changes in price. Although demand generally rises as price falls and supply generally rises as price rises (and vice versa) for most goods and services, the degree to which this holds true is not universal (Elasticity, 2011, Investopedia). Necessities, particularly in the short run — such as gas and staple groceries — are less responsive to price changes than non-necessities.

For example, if the price of gas plummets, in the short term there is only so much "extra" driving someone can or will want to do. Conversely, if the price of gas rises, there is only so much driving a person can eliminate from his or her routine, unless he or she lives in a city like New York with an extensive public transportation system. Demand for non-necessities like Starbucks lattes is likely to increase if the price falls, but decrease sharply if prices rise, since lattes can easily be cut from a consumer's budget.

The Role of Substitutes and Income Elasticity

Another factor that can impact price elasticity is the availability of substitutes. During the 2008–2009 recession, sales of baked beans and supermarket own-brand products rose by over 20% in April 2009 compared with April 2008 (before the recession began). "Sales of organic products, which might be considered 'normal luxury' goods, fell by over ten percent. Consumers are switching away from the pricier organic ranges to lower-priced products. If we take the change in income as minus 4% based on GDP, when it is possible to work out the income elasticity of demand for those products as minus 5 for the baked beans and own brands, and plus 2.5 for the organic goods — all quite significantly income elastic" (Brooks, 2009).

However, what constitutes a "substitute good" may not always be immediately obvious beyond the most basic comparisons, such as apples versus oranges or organic grass-fed beef versus baked beans. Technological products, for instance, involve a high degree of consumer buy-in, which can mitigate the effect of income elasticity and complicate the identification of true substitutes.

Consumer Buy-In and Technological Lock-In

Once a consumer is committed to a particular operating system, switching becomes difficult, rendering that product more likely to be viewed as a necessity — and making substitute goods harder to adopt. For example, when a consumer has purchased a particular computer operating system, even if he or she is dissatisfied with the cost of new software or the system's performance, he or she is less responsive to price changes than a consumer of a product with low exit costs, such as a restaurant meal. Theoretically, a dissatisfied PC user could switch to a Mac, but doing so would be expensive, requiring the purchase of new software and the time investment of learning a new system.

Having a computer is considered a necessity for most households today. Technological lock-in — the accumulation of exit costs that discourage switching — is a key concept in understanding why demand for certain technology products remains relatively inelastic even when prices rise significantly.