Pricing Power

And finance Allah Shmoop what is elasticity Socks underwear rubber

bands slingshots Olympic gymnasts What do these things have in

common while they can stretch In other words they're elastic

This concept comes up in economics It's called drum roll

Please elasticity Shocker bullet measures How much One economic variable

changes when a change is made to another economic variable

Well the most common situation has to do with demand

Like how much does demand change when there's a change

in price I eat price elasticity of demand That's how

you kind of phrase it Well think of it as

meaning or implying how far consumers will stretch their willingness

to buy as price increases like lifesaving prescription drugs Often

there's only one drug that Khun treat a specific disease

particularly rare ones out there Well don't take that drug

and you die People will pay you almost anything to

get it Items like that are said to have in

elastic demand Changes in price don't do much to dent

demand Just grab him out and it looks pretty steep

You know prices go up but demand only changes a

little tiny bit Think gasoline and cigarettes Yeah like that

You need him on the other side Of the spectrum

There are items that have highly elastic demand Little price

changes can dramatically alter whether someone is willing to buy

a product or not Graph him out on the line

looks very flat Let's take ketchup I always do It

goes great on hot dogs So we have some hotshot

new V P at Heinz ketchup and they decide the

brand name of Heinz is worth double any other crushed

tomatoes and a whole bunch of sugar Well anyway they

raise prices So heights now is six dollars for ah

big semi partial gallon of ketchup right there but the

generic Safeway brand or the generic other brand you've never

heard of There are only two dollars and fifty cents

and ketchups kind of ketchup Consumers aren't really that loyal

to it So when you raise prices who bad things

happen behind because well the loyalty that the new VP

of thought that there would be two hind sketch up

wasn't there and consumers were just fine at less than

half the price for the generic brand Yeah very elastic

demand There you raise prices a little bit and boom

volume declines All right so what affects elasticity Well the

first question asked Are there any substitutes you can buy

Prescription drugs might be highly elastic until the generic version

comes out You know kinda like the catch up thing

Right Then all of a sudden the name brand version

loses a lot of its pricing power Right Well another

key question What kind of commodity is it like Is

it a necessity or a luxury like waters A necessity

but lots of substitutes for the way you buy water

Right And how high is the price level To start

What Manufacturers can probably sneak a five percent price increase

you know on say a dollar package gun But that

same five percent price increase to a Mercedes Well that

would bump the price of it You know like several

thousand dollars right They start out at seventy grand You

raised five cents and thirty five hundred bucks Thank you

very much All right Well can you wait to buy

that car then Kenya Well if you're planning that Mercedes

purchased well you might be able to push it off

a year or two if you you know think the

price is too high Another few thousand miles on the

odometer won't affect trade in on your old crappy Volvo

car Too much so you drive However if you're broken

down by the side of the road in Death Valley

and the only tow truck driver within a hundred miles

says it will be one hundred fifty dollars to come

Get your car Well you either pay or you know

start walking How long you have The product also plays

into the price elasticity of demand Disposable products can be

pretty cheap and elastic in terms of price right Think

those disposable plastic razors in Scooby Doo Band aids and

you know packs of gum But if you can get

a long term used out of something while the price

could be higher think stuff like refrigerators or cop water

heaters and well yeah that Mercedes luxury Your income is

another factor in determining elasticity as well All right going

back to Mercedes here a five percent increase in the

car price might put it out of your range Well

what if we go with the used Ford Fiesta Yeah

well I'd save you a whole bunch of money It

was fun to drive But then if wealthier Jeff Bezos

richest man in the world for that five percent increase

wouldn't even register Pete by the Mercedes anyway the way

the rest of us by a hamburger for lunch And

then well he might use it as a flowerpot in

his backyard So a lot goes into price elasticity Unfortunately

economists have an equation for all this stuff to figure

out something's elasticity while we take the percentage change in

the quantity of something and divide it by the percentage

change in the price when different prices and demand levels

and curved shapes are involved here So if the result

gets you a number greater than or equal to one

in this little graph equation here then that product is

considered elastic meaning a change in price is highly sensitive

It has a notable effect on demand You raise it

a little bit in demand shrinks those easy to find

products where there are a lot of potential substitutes Yeah

they're usually highly elastic They compete on price Remember the

great ketchup dilemma Yeah that's got an elasticity greater than

one And then there's the other side of the coin

If you run the last two city equation and get

a result less than one Well then you've got an

elastic product Consumers don't change how much they purchase one

Prices rise Well think about gasoline We're not talking about

the price of anyone station You know if the place

by your house jacks up prices well you'll just drive

around the block and goto cheaper place right But if

gas in general skyrockets like say there's a revolution in

the Middle East or if hurricane takes out all the

oil rigs in the Gulf of Mexico Well then gas

prices all over the world spike But what do you

do You know that's you grumble You complain you post

mean Twitter comments about gas state Asian owner but ultimately

you drive on over and pump the gas Well you

don't have much of a choice here for normal people

in normal gas powered cars That's inelastic demand even when

there are big moves in price while you find a

way to pay it In other words well you're about

as flexible in that regard as that gymnast I do