What Is Choke Price?
Choke price is an economic term used to describe the lowest price at which the quantity demanded of a good is equal to zero. On a graph of supply and demand, it is the point where the demand curve intersects with the vertical axis.
- The choke price is the exact price level where demand for a product becomes zero.
- As pricing nears the choke price, consumers start to search for alternatives.
- The choke price is most often referenced in terms of commodities and natural resources.
- In times when demand is high, companies want to price their goods nearer to the choke price to fully realize the market opportunity.
Understanding Choke Price
The importance of choke price lies in that it graphically delineates the price at which demand ceases. At any price below the choke price, consumers will demand some quantity of the good. At any price equal to or above the choke price, consumers will not express any demand for the good.
In basic terms, the choke price is the price that no one is willing to pay for the good in question. The choke price is the exact point at which demand ceases, making it an economically significant data point for understanding the dynamics of demand for that product. Buyers are, of course, equally uninterested in any of the higher possible prices for the good, but the choke price is the lowest price at which there is zero demand. Financial analysts often use the choke price to analyze supply and demand.
The choke price is most commonly used to refer to commodity pricing, but it applies to any good. There are choke prices related to oil, natural gas, electricity, and so on. As the price nears the choke price, it encourages more buyers to look at substitutes and alternatives. The term choke price may also be applied to price points where demand drops faster than expected, but this is an informal usage rather than the correct economic one as demand is lower but still exists.
By using a demand schedule, or demand curve, a company can see where the choke price is as well as the differences in the quantity of a good that consumers will demand at different prices. For example, consumers might purchase 200 units of a good at $40, 1,000 units of a good at $20 and 2,500 units at $10, but zero units at $50. Therefore, the choke price must be somewhere above $40 and at most $50, though we can never discover the exact choke price.
Note that this is always the case; the exact choke price can never be reached because by definition no transactions occur at this point. We can only say for sure that the choke price is somewhere above the price at which buyers will demand 1 unit of a good. This means that the choke price is never actually observed, but may be extrapolated from an econometrically estimated demand curve as the point where the demand curve (theoretically) intersects with the vertical axis on a supply and demand chart.
In practice, this choke price is almost never approached for several practical reasons. Producers often tend not to continue raising prices once demand gets very low, since dropping to zero sales may mean going out of business. For most goods, the minimum efficient scale of production will be such that the market price that buyers will pay for that number of units of the good will be the effective choke price.
Rising and Lowering Choke Price
Shifts in demand have a direct impact on the choke price. Imagine that consumers see a rise in income. This extra income can cause demand for a normal good to rise. Demand typically becomes less elastic in this situation as well, so a firm should consider raising its prices. With linear demand, an increase in income causes the demand curve for a normal good to shift to the right without changing its slope. So the choke price rises and demand becomes less elastic, and the volume goes up as well. Regardless of whether the company has constant or increasing marginal cost, it should probably increase its price to capture the market opportunity fully.
Similarly, price increases can have a lowering effect on the choke price. A price increase on a complementary good will usually lower demand for the complementary good. Such an increase usually makes the demand for the firm’s good more elastic. With linear demand, an increase in the price of a complementary good causes the demand curve to shift to the left without changing in slope. So the choke price falls, and demand becomes more elastic, meaning a company has to be flexible on the pricing downside to be competitive.