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Inelastic Demand

by domyy
Tags: demand, inelastic
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domyy
#1
Apr24-12, 07:51 PM
P: 222
Hello!

I know that inelastic demand is normally linked with necessities.

However, if I have a superior good, and thereīs an increase in price, customers still would buy the product because of the prestige, the brand.

So, I am writing a paper about a firm and my professor wants me to discuss ALSO the elasticity of demand for my product - which happens to be a superior good.

I know that increase in price lead to more revenue for my firm. So I must say my product is inelastic. However, I am reluctant to say this because, as I said, I studied that normally only necessities are inelastic.

I talked to my professor and asked if instead I could mention my product had a high income elasticity of demand and that would make more sense. But he said no.

So, can I simply say my product is inelastic if itīs a superior good but increase in price lead to higher revenue?

Or I should say my product is elastic; elasticity greater than 1?

Because they all sort of make sense to me
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Bipolarity
#2
Apr24-12, 10:13 PM
P: 783
Either you or your professor is confusing price elasticity with income elasticity. Your professor probably omits the negative sign from price elasticity. Avoid this.
The terms "inelastic","elastic","perfectly elastic" and "Giffen" are used to describe only price elasticity.

For price elasticity:

Perfectly elastic if [itex] e = -∞ [/itex]
Elastic if [itex] e < -1 [/itex]
Unit elastic if [itex] e = -1 [/itex]
Inelastic if [itex] -1 < e < 0 [/itex]
Perfectly inelastic if [itex] e = 0 [/itex]
Giffen (violates law of demand) if [itex] e > 0 [/itex]



The terms "normal", "sticky", "inferior" and "superior" are used to describe only income elasticity.

For income elasticity:

Inferior if [itex] e < 0 [/itex]
Sticky if [itex] e = 0 [/itex]
Superior/Normal if [itex] e > 0 [/itex]

BiP
domyy
#3
Apr24-12, 10:26 PM
P: 222
I guess I am the one confusing the subjects...
I am supposed to, then, simply discuss if my firm has an elastic or inelastic demand. My firm deals with clothing. However, high prices lead to higher revenues. I guess that means my firm has an inelastic demand, right?

Bipolarity
#4
Apr24-12, 10:54 PM
P: 783
Inelastic Demand

First of all, how do you know that higher prices lead to higher revenues?

You mentioned that the good is superior. That does not mean that higher prices lead to higher revenues. In fact, that means higher income leads to higher demand that's all.

BiP
domyy
#5
Apr24-12, 11:18 PM
P: 222
Well, because thatīs what I found on researches.
They are active only in three countries; are not popular but they are making greater revenues each year. Supply is deliberately smaller than demand and this scarcity is also the reason why people want to buy their products.

I am not even supposed to discuss what type of product I have but just the elasticity of demand.

I know that my firm targets high income individuals whose purchasing power is not affected by macroeconomic downturns. So, they sell expensive products and people buy them.
Therefore, their high prices only lead to high revenues. Unless of course thereīs a change in the average income. But my researches show that even during the recent recession, their sales kept growing...and the reason for that must be the type of customers they are aiming at.

But my professor only cares about the elasticity of demand. Thatīs all he wants.

ps: I thought that part of selling a superior good is to have it expensive, scarce and offer prestige. I guess this product would then fall in this category. If you are scarce, revenue does not come from a large quantity sold but smaller quantity for higher price.
Bipolarity
#6
Apr24-12, 11:30 PM
P: 783
Quote Quote by domyy View Post
Well, because thatīs what I found on researches.
They are active only in three countries; are not popular but they are making greater revenues each year. Supply is deliberately smaller than demand and this scarcity is also the reason why people want to buy their products.

I am not even supposed to discuss what type of product I have but just the elasticity of demand.

I know that my firm targets high income individuals whose purchasing power is not affected by macroeconomic downturns. So, they sell expensive products and people buy them.
Therefore, their high prices only lead to high revenues. Unless of course thereīs a change in the average income. But my researches show that even during the recent recession, their sales kept growing...and the reason for that must be the type of customers they are aiming at.

But my professor only cares about the elasticity of demand. Thatīs all he wants.

ps: I thought that part of selling a superior good is to have it expensive, scarce and offer prestige. I guess this product would then fall in this category. If you are scarce, revenue does not come from a large quantity sold but smaller quantity for higher price.
Revenue has no direct relationship with income elasticity. Revenue only has direct relationship with price elasticity, chiefly because revenue is the product of quantity and price.

Does your professor ask for income or price elasticity? Price elasticity in your case is clearly greater than -1, but do you have enough information to specify whether its between -1 and 0 or whether its greater than 0?

Also, if you are sure that the good is superior then you can conclude that income elasticity is greater than 0.

BiP
domyy
#7
Apr24-12, 11:40 PM
P: 222
price elasticity of demand. Oh no, I think I am mixing everything.
My prof. said we donīt need to find numbers but just discuss whatīs the price elasticity of demand. This is confusing to me.
Bipolarity
#8
Apr24-12, 11:47 PM
P: 783
Quote Quote by domyy View Post
price elasticity of demand. Oh no, I think I am mixing everything.
My prof. said we donīt need to find numbers but just discuss whatīs the price elasticity of demand. This is confusing to me.
Don't worry. It's easy to get confused. The terms have similar names.
If you only need price elasticity, you can completely ignore the fact that the good is superior. Superior goods is related to income elasticity, which you don't need.

Since you're talking about price elasticity, first thing you want to know is how revenue will be affected if the price changes. If price and revenue go in the same direction, then you can conclude that the elasticity is greater than -1. In your case, because the good is so popular that its sales actually increase if its price increases, the elasticity must be greater than 0. Thus the good is a Giffen good and it fails to obey the law of demand.

There are generally very few goods out there that disobey the law of demand, but they do exist and we call them Giffen goods. A prime example is jewellery and precious metals. Usually if the price of such goods increases, demand also increases. Violation of law of demand.

Stocks are another big example of Giffen goods is stocks. If stock prices go up, demand goes up, which creates a vicious cycle.

Many luxury goods are also Giffen goods because people buy them out of the fact that they are highly priced rather than because of their physical utility.

BiP
domyy
#9
Apr24-12, 11:47 PM
P: 222
My product is not something that the more expensive it gets, the more people want it.
Itīs just something that became a brand and people buy the brand. Its not very scarce but they do have supply < demand.
domyy
#10
Apr24-12, 11:50 PM
P: 222
So, that still falls in the Giffen good category, right?
Bipolarity
#11
Apr24-12, 11:54 PM
P: 783
Quote Quote by domyy View Post
So, that still falls in the Giffen good category, right?
Let me ask you this question about your good:

If you increase the price of your good without changing anything else , will people increase or decrease their demand for it? Or does demand not change at all?

If you answered "increase" --> your good is a Giffen good
if you answered "decrease" --> your good is inelastic
if you answered "demand does not change at all" --> your good is perfectly inelastic

EDIT:
The brand name is important in drawing customers, but it has no relation with price elasticity so it is not really worth mentioning.

BiP
domyy
#12
Apr25-12, 12:04 AM
P: 222
I guess my product is inelastic then.
What bothers me is the fact that my product has maintained the same average price for their products for the past 2 years, letīs say. Itīs high compared to the substitutes but people still buy them whereas they could be buying something else.
I donīt have proof of raise to confirm that demand would decrease. I just know that their revenues have been increasing over the past years.
I am having trouble putting this together. What does that tell me?
I am guessing that if there are substitutes and people stick to this brand, itīs because theyīre inelastic then, right?
Also another situation that could lead to this conclusion is the fact that during recession, sales didnīt drop. Instead, grew compared to the previous year.
Bipolarity
#13
Apr25-12, 12:16 AM
P: 783
Quote Quote by domyy View Post
I guess my product is inelastic then.
What bothers me is the fact that my product has maintained the same average price for their products for the past 2 years, letīs say. Itīs high compared to the substitutes but people still buy them whereas they could be buying something else.
I donīt have proof of raise to confirm that demand would decrease. I just know that their revenues have been increasing over the past years.
I am having trouble putting this together. What does that tell me?
I am guessing that if there are substitutes and people stick to this brand, itīs because theyīre inelastic then, right?
Also another situation that could lead to this conclusion is the fact that during recession, sales didnīt drop. Instead, grew compared to the previous year.
Based on what you just said, Yup I would agree that the good is inelastic. A good example of an inelastic good is food. Even in wartime, you must continue to buy food otherwise you will not survive. Your choice of food may change, but food is still food. Even if the price of food goes up by a 100, you will still buy it because it is more important than everything else. IF you cannot afford it at the high price, then there's a big problem.

BiP
domyy
#14
Apr25-12, 12:27 AM
P: 222
But food is a necessity and this company is in the clothing industry. They just sell because they became a brand. I guess thatīs what bothers me. Can I still say itīs inelastic?
Bipolarity
#15
Apr25-12, 12:30 AM
P: 783
Quote Quote by domyy View Post
But food is a necessity and this company is in the clothing industry. They just sell because they became a brand. I guess thatīs what bothers me. Can I still say itīs inelastic?
There could be many reasons why a good is inelastic. Necessity is only one of them. Being a big brand name could be another reason... usually necessity is a much better reason however. But I would argue that clothing is also something of a necessity, particularly in the United States :D
IT depends on what clothing though. Thick jackets are not a necessity unless you live in Vermont :D

BiP
domyy
#16
Apr25-12, 12:53 AM
P: 222
I donīt think people buy it because itīs a necessity. Itīs more a preference for the brand and MAINLY design.

But actually I just recalled something. I know they are the biggest firm (pioneer) selling this type of clothing...there are others...but not as popular. So I guess that would be a good reason to say they have a sort of inelastic demand.
domyy
#17
Apr25-12, 01:04 AM
P: 222
Oh I think everything is getting clearer now. I have a direction and better idea of what I should do!!

Thank you SO MUCH!!!!
nitsuj
#18
Apr25-12, 03:45 PM
P: 1,098
Quote Quote by domyy View Post
price elasticity of demand. Oh no, I think I am mixing everything.
My prof. said we donīt need to find numbers but just discuss whatīs the price elasticity of demand. This is confusing to me.
Ignore how these concepts apply to your "business model" and focus strictly on the relationships describe in the various supply/demand concepts.

At this level of evaluating comprehension of comparatively simple concepts, I'm sure you would be able to find diagrams that illustrate these concepts visually (which tends to be easier to "absorb").

Or choose a product that is an "extreme" example. Something like insulin, or plain white t-shirts have obvious Supply demand relationships with respect to price.


EDIT: Opps, I guess I should have finished reading this thread before replying....


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