Many of these will help individuals to know how to manage supply, demand and pricing questions. Unit elastic demand is one such theory.
What Is Unit Elastic Demand?
In economic terms, unit elastic demand refers to when demand affects the price of a product. This is seen when the price of something is reduced and it increases sales. In business terms, unit elastic demand is used to help businesses know when to raise and lower the price of their products or services.
How Does a Company Know if They Have Unit Elastic Demand?
Unit elasticity can be worked out as an equation or graph. By calculating the elasticity as an equation, business owners and economists are able to see whether something is elastic or inelastic. A score of 1 or higher is considered elastic, so a score of below 1 would be inelastic. For something to be considered unit elastic, it would need to score 1 or above. If a company is unsure whether their products have unit elasticity, they usually calculate a supply or demand curve. This is a visual representation that shows how demand changes in relation to price. When something is unit elastic, price and demand have an equal and opposite effect on each other. For example, a 1% increase for one will mean a 1% decrease for the other.
What Does ‘Elastic’ Mean?
When someone talks about elasticity or something being elastic in a business context, they are referring to how responsive different variables are to one another. When demand for a product is described as being elastic, the level of demand will impact the price of a product. An example of this is the housing market. When there is a lot of demand for properties, the prices are pushed up. When there is less demand, prices remain stable or are reduced. The demand drives the price.
Elasticity of Demand Vs Unit Elastic Demand
As previously discussed, unit elastic demand refers to the direct relationship between the cost of a product or service and the demand for it by consumers. It is the principle that one has a direct and proportionate effect on the other. Unit elasticity states that if a price rises by 10%, demand decreases by the same amount. Elasticity of demand is a broader term used to describe the relationship between demand for a product or service and its price. There are a variety of different elasticity concepts within economics. Typically there are three terms used to describe elasticity of demand:
Perfectly inelastic demand Relatively elastic demand Relatively inelastic demand
The main difference between these types of demand elasticity is that they aren’t always proportional. With unit elasticity, the changes in demand and price are always proportional to one another. In a situation that doesn’t have unit elasticity, it is possible that if the price lowers by 15%, then demand might only rise by 7%.
Examples of Unit Elastic Demand
Example One
When prices are lowered, companies will typically expect to see an increase in demand. When something has unit elasticity, this increase will be proportional to the reduction in cost to the consumer. A company sells 1,000 cell phone screen protectors for $1.95 each. The company owner decides to run a special offer and decreases the price by 15%, so they are now $1.66 each. If the product has unit elasticity, the company would expect to sell 1,150 products in a week. They will have sold 15% more screen protectors at the lower price.
Example Two
A supermarket has held their price of milk low for a long period, but market changes mean that they need to increase the cost to the consumer. In a unit elasticity situation, they would sell fewer products as a result of the increased price. Before the price increase, they sold 2,500 gallons of milk per month for $3.50 a gallon. Then, the price increases by 10%, so it now costs $3.85 per gallon. A unit elasticity situation would mean that the company would expect to sell 10% less milk at the new higher price. They would sell 2,250 gallons each month. It can help them to predict trends within the market, inform them on the success of advertising campaigns, help them to understand the feelings of their consumers and offer the potential for possible investment opportunities.
Business Planning
Any business needs to have a business plan. It’s how they decide the targets they would like to meet and the steps needed to achieve their goals. This often isn’t a fixed timeline or roadmap to a goal, but will act as a guide to focus on where the company sees itself in the future. Having a product that has unit elastic demand can make business planning easier, as company owners can more accurately predict the changes that are needed to go in the direction they want. For example, if they had a surplus of products, they might consider lowering the price so they can increase demand. This would allow them to sell their surplus, while also ensuring that they don’t take a dip in their overall income.
Availability of Investment Funds
As a rule, investors like to choose companies that are safe and reliable. They are less likely to back a business that comes with a high degree of risk, unless it can also give them a high level of return. Companies that have a unit-elastic product can attract investment from a wider variety of sources. They know that, whatever is done to the price, there will be a proportionate increase in demand. Their money will be relatively safe. It can also offer companies more opportunities for self-investment than they would perhaps have had if they didn’t have unit elastic demand. This is because they know there are ways to increase revenue without losing all their demand. A short-term price increase could lead to fewer customers during that period, but when the price goes back to normal, the demand will increase again.
Marketing Campaign Success
If a company runs a special offer or marketing campaign, their unit elastic demand can help to predict how successful it will be. By understanding the relationship between price and demand, businesses are better able to target their advertisements and decide pricing brackets. They are also able to more accurately simulate what expected sales could look like.
Informed Price Setting
Companies with unit elasticity can create accurate models and demand graphs that predict how consumers will react to pricing changes. They are better informed about how best to price their products so that they can achieve the highest possible sales and profits.
Able to Adjust to Market Changes
The more that a company knows about their suppliers, consumers and products, the easeier they can react to changes within their chosen market. No market will ever stay static, and changes in the cost of components from suppliers, delivery costs or any number of other variables can mean that it is necessary to adjust pricing to compensate. It could be that there has been a reduction in the overheads of a company and they want to pass this on to the consumer. Alternatively, the cost of parts from a certain supplier may have increased and this will also need to be passed on. By fully understanding and anticipating changes in demand when prices change, companies can predict what will happen and compensate for this. It allows increased flexibility and they are less affected by negative changes in the economy compared to their competitors.
Final Thoughts
It is very rare for a company to achieve unit elasticity. Usually there is some sway in one direction or the other, even if only by the tiniest margin. But, from a business perspective, looking at a perfect unit elastic curve can provide valuable insight and guidance when it comes to making changes to pricing structures or products. It can help company owners to accurately predict how their consumers will react and allow for longer-term planning.
