Price inelasticity is very beneficial for businesses. It offers firms greater flexibility with prices while the percentage change in demand it generates remains essentially the same. Whether the price goes up or down, you can expect consumers’ buying habits to stay mostly unchanged.
How Price Inelasticity Affects Demand
For price-inelastic goods or services, a percentage change in quantity demanded is minimal with respect to a percentage change in price.
This has great implications for businesses and affects demand and total revenue in two ways.
1. If prices for inelastic goods are lowered, the quantity demanded wouldn't offset the decrease in price. This would result in less revenue. The firm would then run at a loss and should not really reduce the price of its goods.
2. On the other hand, if prices for inelastic goods are increased, the total revenue increases, but it would lead to a small decrease in quantity demanded.
This means that firms that deal in inelastic goods or services can increase prices, selling a little less but making higher revenues. Therefore, businesses that deal in goods that are price-inelastic are better equipped for profit maximization and better protected against downturns.
Price inelasticity shows that customers – and by extension, demand – are more tolerant to price changes. Therefore, firms that deal in inelastic goods or services can transfer the extra cost of production to their customers without adversely affecting the demand. So, price inelasticity offers a better flexibility at setting up or establishing pricing strategies.
When Does Price Inelasticity Typically Happen?
Price inelasticity usually occurs with products that have fewer close substitutes, which means fewer options for customers. Such goods tend to be necessities that people can't do without.
To enhance pricing flexibility and profit maximization, firms can strive to create or deal in more customized or distinctive goods or services. Sophisticated brands also possess greater inelasticity. Thus, many companies that sell distinct luxury goods make great profit. Firms that deal in more ordinary products typically need to reduce prices and sell at competitive rates to gain an edge over competing brands.