When increase in the price of a product causes a more than corresponding drop in its demand level and vice versa, that product is considered a price elastic product. The price elasticity of a product is measured by the percentage increase or decrease in quantity demanded in relation to the percentage increase or decrease in price. In a competitive market when products are price-elastic, the businesses find it difficult to make profits, because the prices have to be kept low in order to maintain the demand.
Before taking up a business dealing with the sales of price-elastic products, its important to check the demand level of the product, or else the business will find it difficult to post profits. There are certain products, which are always in demand and an increase, or decrease in price, does not affect its demand. Such products are mostly found in monopoly market, where a particular firm or individual has enough control on its products and service and can change the product price or terms according to their wish. Here the owner can increase price relevantly to earn profits. But in the case of price-elastic products, demand becomes high with decreasing price, and sales revenue will also grow high, but profitability will remain relatively lower.
Before taking up a new business, the owner should take into account the price-level of the commodity, which can fluctuate in relation to the ratio of the quantity available in the market and demand for that commodity among the consumers. The price of the product is affected by several factors other than the supply and demand such as the government regulations like taxes, price fixing etc. and the availability of close alternative commodities.
The price-level of a product is said to be in the equilibrium point where demand for a product is equal to the quantity supplied. This point is the ideal time for doing business. For example, if there is an increase in demand, the supply of the product will increase and unless the equilibrium is reached, it will result in an increased price level. However, due to increased price rates, the demand will gradually come down and there will be excess stocks, now the sellers will have to reduce the price for sale of thee excess goods, which will in turn increase the demand for the product resulting in shortage of the product, under the situation the sellers can again increase the prices and earn money.
For doing any business, the study of market structure is important, as also to learn to what extent the market can tolerate the price increase on a product without adversely affect its demand. While indulging into a business of price elastic products, the total revenue can come down if price is conspicuously raised.
With inelastic demand, however, total revenue will increase if the price is raised, which also depends on reaction of competitive firms. For example if all firms are ready to lower its price in competition, then demand will become inelastic and price war will bring only a small percentage increase in sales.
“If a firm is producing a good with economies of scale. Cutting prices will enable lower average costs because output can increase, this could even increase profitability.” (Pearson, 2008).
Doing business of price elastic goods can be profitable when the prices are just low enough to maximize the demand. With economies of scale, it should work out in favor of the business. The importance is to make the revenue more than the cost incurred for production. Under a perfectly competitive market, no business can decide price of the products and the market is the one that determines price. Therefore when the demand for the product is high and price is as such that it doesn’t affect firm’s profitability, and demand is equal to supply, the business can be done with good revenue.
Economics basics: Demand and supply. (2008). The wall street journal. Investopedia. Web.
Pearson, Chris. (2008). Price Elastic Products – Are There any benefits? Economics Help: Helping to simplify Economics. Web.