Inelasticity of Demand and Your Pricing Strategy

Last week, Marka and the tribe discussed how understanding price elasticity can help businesses like FEI arrive at an intelligent pricing strategy. This week, they discuss inelasticity of demand and its applications to pricing. Remember, fire = print.

Marka stood in front of the FEI tribe holding a Slinky. “As we discussed last week, elasticity is how responsive demand is to a change in price. This Slinky will help us understand the concept of inelastic demand. Say its length represents a product’s price and its width represents a product’s demand. Now let’s raise the price of our product that’s experiencing inelastic demand,” she said, extending the Slinky as far as it would go.

“The width doesn’t change,” Zoot observed.

“Yes, exactly,” Marka said. “If a company determines its product is experiencing inelastic demand, it can raise the product’s price with a relatively limited effect on demand.”

“How can companies create inelastic demand for their products?” Numo asked.

“One way is to simply own a monopoly on a market or product category,” Marka replied. “In this case, consumers don’t feel they have much of a choice and will be forced to pay much higher prices.”

“Another is to develop highly-differentiated brands and products,” she continued. “Grape Computers, for example, commands almost twice the price of competing models because consumers perceive its brand and products as unique, with benefits not offered by competing, lower-priced models.”

“No product is 100 percent inelastic,” Numo pointed out. “This only exists in Economics textbooks. Grape knows it would move more units at a lower price, but the company determined its profitability would be maximized at a high price point—just not crazy high.”

“Is demand for our new matches elastic or inelastic?” Zoot asked.

“Relatively inelastic...for now,” Marka said. “There’s currently no competition for our matches, which in theory means demand should be relatively inelastic. There are substitute products out there, however, such as Flintstone’s flints. If we price our matches too high, consumers may stick with the flints even though they’re less convenient. But the current lack of competition for our new product may allow us to charge two or three times what we could in a more crowded market.”