Price inelasticity is very beneficial for businesses and is important in understanding how they should formulate their pricing strategy. Price inelasticity offers firms greater flexibility with prices as the change in demand remains essentially the same whether prices increase or decrease. If 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, the change in the amount demanded is minimal with respect to the change in price.
This can affect demand and total revenue for a business in two ways.
Less Overall Revenue
If the price for an inelastic good is lowered, the demand for that good does not increase, resulting in less overall revenue due to the lower price and no change in demand. This would indicate that the firm should not reduce the price of its goods as there is no beneficial outcome in doing so.
More Overall Revenue
On the other hand, if the price for an inelastic good is increased and the demand does not change, the total revenue increases due to the higher price and static quantity demanded. However, price increases typically do 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 are better protected against economic 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. As a result, price inelasticity offers better flexibility at setting up or establishing pricing strategies.
When Does Price Inelasticity Typically Happen?
The main factors that determine demand are price, price of substitutes, income, taste, and expectations of future price changes. Other minor factors do come into play, such as brand loyalty.
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 and therefore their needs stay the same. Examples of inelastic goods include basic food, gasoline, important medicine, such as insulin, and habitual goods, such as tobacco products.
To enhance pricing flexibility and profit maximization, firms can strive to create or deal in more customized or distinctive goods or services where there are few close substitutes as sophisticated brands possess greater inelasticity. Though luxury items are typically price-elastic, many companies that sell distinct luxury goods that are unique, tend to experience some inelasticity.
An example would be Apple's iPhone. Slight increases in the price would not adversely affect the demand for the phone. On the other hand, firms that deal in more ordinary products typically need to reduce prices and sell at competitive rates to gain an edge over competing brands.