So you got a great idea and want to put it into action, so you can go ahead, right? Slow down there, you need to know about elasticity.
Lets start:
First, terms:
Elasticity: The responsiveness of demand or supply to a change in a factor of either, although I will be focusing on price
Inelastic: When the change in a factor of demand or supply causes a smaller change in demand or supply (When elasticity<1)
Elastic: When a change in a factor of demand or supply causes a larger change in demand or supply (When elasticity>1)
Unitary: When a change in a factor of demand or supply causes the same change in demand or supply (When elasticity=1)
Demand: The willingness and ability of consumers to purchase a good at a certain price
Supply: The willingness and ability of suppliers to provide a good at a certain price
Price Elasticity of a product can be calculated like this:
(Quantity sold after price change) - (Quantity sold before price change)
Quantity sold before price change
(New Price)-(Old Price)
Old price
So now, what does this have to do with running a business? And what the hell does that equation have to do with profits?
Well knowing this will help you to be able to maximize profits by knowing the effect price changes have on your customers. The general rule is, if your demand is elastic, lower the price, if it is inelastic, raise the price, and if it is unitary, do whichever you want, nothing will change. Now for an example:
You own a business that sells computers for $1000 each. It costs $600 to build one computer. Your profits have been declining recently so you decide to do a demand and supply analysis. The results of the analysis said that the elasticity of your product was 3.
In this case, you would lower the price from $1000 to approximately $800 (20%), and you would see a great increase in sales by approximately 60%. However, had the elasticity been less than 1, the correct thing to do would be to raise prices.
Now that you understand how elasticity works, you can put it into practice and hopefully see an increase in your profits.
Lets start:
First, terms:
Elasticity: The responsiveness of demand or supply to a change in a factor of either, although I will be focusing on price
Inelastic: When the change in a factor of demand or supply causes a smaller change in demand or supply (When elasticity<1)
Elastic: When a change in a factor of demand or supply causes a larger change in demand or supply (When elasticity>1)
Unitary: When a change in a factor of demand or supply causes the same change in demand or supply (When elasticity=1)
Demand: The willingness and ability of consumers to purchase a good at a certain price
Supply: The willingness and ability of suppliers to provide a good at a certain price
Price Elasticity of a product can be calculated like this:
(Quantity sold after price change) - (Quantity sold before price change)
Quantity sold before price change
(New Price)-(Old Price)
Old price
Well knowing this will help you to be able to maximize profits by knowing the effect price changes have on your customers. The general rule is, if your demand is elastic, lower the price, if it is inelastic, raise the price, and if it is unitary, do whichever you want, nothing will change. Now for an example:
You own a business that sells computers for $1000 each. It costs $600 to build one computer. Your profits have been declining recently so you decide to do a demand and supply analysis. The results of the analysis said that the elasticity of your product was 3.
In this case, you would lower the price from $1000 to approximately $800 (20%), and you would see a great increase in sales by approximately 60%. However, had the elasticity been less than 1, the correct thing to do would be to raise prices.
Now that you understand how elasticity works, you can put it into practice and hopefully see an increase in your profits.
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