Last week, Marka and the tribe discussed the importance of determining a company’s pricing objectives. This week, Marka defines price elasticity and explains how knowledge of this concept can help businesses like FEI arrive at an intelligent pricing strategy. Remember, fire = print.
FEI’s morning conference meeting was underway, but Zoot was busy playing with a rubber band.
“Give me that,” Marka chided, snatching the rubber band from Zoot. “This will make a great visual aid.”
Marka stood before the tribe and dangled the rubber band in order to get everyone’s attention.
“Careful, you’ll drop it!” Zoot cried.
“Today we’re going to talk about elasticity of pricing demand,” Marka said, holding up the unstretched rubber band, which was equal in width and length. “If you increase this band’s length, its width will shrink. Say this band’s length represents price and its width represents demand. As the price increases…[Marka stretched the rubber band lengthwise to visually indicate the change in price] the quantity demanded decreases [the band’s width shrank correspondingly].”
“So with elastic demand, an increase in a product’s price causes the quantity demanded to go down?” Zoot asked.
“Precisely,” Marka said.
“And what types of products are likely to encounter elastic demand?” Org asked.
Marka listed off on her fingers:
- Products that are perceived as commodities or near-commodities
- Products for which there are intense competition or numerous substitutes
- Products/brands that have been poorly differentiated
“In these and other cases, a price increase gives consumers less of an incentive to purchase the product,” Marka said. “Most of the time, they’ll simply go with the cheaper option.”
“So how can we use what we’ve learned today to determine pricing strategy for our products?” Numo asked.
“FireClassic is an example of a product with elastic demand,” Marka said. “Whenever we increase prices a half drachma, sales plunge and we make less profit even though we’re charging more.”
“Yeah, we’ve learned not to do that over the years,” Numo agreed. “But won’t matches be a different story?”
“Yes,” Marka said. “The demand for these products would be categorized as inelastic. Next week we’ll discuss price inelasticity, the other side of the pricing coin.”
Today’s FIRE! Point
With elastic demand, an increase in a product’s price causes the quantity demanded to decrease. Products likely to encounter elastic demand include those perceived as commodities or near-commodities, those for which there is intense competition or numerous substitute choices and those that have been poorly differentiated. In these and other cases, a price increase gives consumers less of an incentive to purchase the product.FIRE! in Action:
An electronics retailer sold 27˝ televisions at four different price tiers. By slightly lowering the price of the third-tier Sharp model, the retailer increased demand and the profit it gleaned
from this product. Next week: The FEI tribe discovers inelasticity of demand.