Elastic demand refers to the variability in the number of units sold when the price of a product or service changes. The concept is used to set the prices of products and services. A product is said to have elastic demand if sales drop in concert with an increase in price, or sales jump in concert with a decrease in price. In some cases, the quantity sold does not change appreciably, even when there is a significant change in price. If so, this is called inelastic demand.
From a pricing formulation perspective, elastic demand is of considerable concern. If it is not possible to increase prices without experiencing a sharp decline in sales volume, a business must essentially rely on cost reductions or expansion into new sales regions to generate a profit over the long term. Price elasticity is particularly common when the products of competing companies are not well differentiated, or where substitute products are readily accessible.
Conversely, a company is in a much better position when customers are willing to accept price increases and still maintain approximately the same sales volume, thereby increasing company profits. Inelasticity arises when a company can clearly separate the features of its products from those of competitors, and customers assign value to these differences.
Elastic demand can be defined with the following formula:
% Change in unit demand ÷ % Change in price
A product is said to be price inelastic if this ratio is less than 1, and price elastic if the ratio is greater than 1. Revenue should be maximized when you can set the price to have an elasticity of exactly 1.
Elastic demand is also known as price elasticity of demand.