When demand for a product does not increase or decrease correspondingly to change in price demand is said to be inelastic. It means that people won’t buy more of it if the price goes down, or buy less if the price goes up.
It’s important to note that the concept of perfect inelasticity – in which there is absolutely no change in demand regardless of price – is largely theoretical. In the real world there will almost always be small changes in demand but as long as the change in demand is smaller than the change in price it is still considered to be relatively inelastic, and we usually just say “inelastic”.
Let’s say that you sell, on average, twenty $40 flower bouquets each week – generating $800 in revenue.
If you increased the price to $50 and still sold sixteen or more – generating $800 or more in revenue – demand would be considered inelastic. The decrease in demand was less than the increase in price. You generate as much or more revenue as you did before at the lower price.
What does this mean to the seller? It means that increases in price are relatively safe, as the revenue added from the higher price will exceed the revenue lost because of decreased demand. It also means that sales are not a very effective way of increasing revenue.
The factors below contribute to price inelasticity of demand, especially when two or more are present.
A common example is essential medicine where no substitute (like a generic equivalent) is available. As the price goes up the effect on demand is relatively small – most people will find a way to cover it. Conversely a decrease in price does not cause increased demand – people are unlikely to consume medicine they don’t need just because it is more affordable.
Another common example is gasoline. Increased prices have little effect on short term supply.
It’s not the zero effect on demand that would create perfect inelasticity, but a relatively small effect. If prices drop people are more likely to take advantage and fill up even if their tanks aren’t anywhere near empty. If the prices go up people may opt to wait a few days in the hope of a decrease, cancel discretionary trips or seek alternate form of transportation.
There is an effect on demand, but it is less than the change in price so gasoline is considered to be inelastic.
In the longer term gasoline is substantially less elastic. When faced with significant long term increases in fuel prices people will make different choices in the vehicles that they drive. As gasoline prices topped $4 a gallon in the summer of 2008 sales of gas-guzzling vehicles like Hummers dropped. It is still however relatively inelastic.
Once again changes in price have little effect on demand for cigarettes. The decrease in demand is more significant among youth that typically have less money to spend, but among all smokers the change in demand is less than the change in price.
Commonly cited as examples of inexpensive and infrequently purchased goods with no real alternatives.
The pattern is fairly easy to spot. If a good is essential (like medicine or gasoline) or addictive (cigarettes) and there are no real alternatives then demand is likely to be inelastic.
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