Last modified on 22 February 2011, at 02:19

AQA Business Studies/Elasticity of Demand

Elasticity of Demand is the term used to describe the difference between the price of a product and the demand. Generally the higher the price of the product the more the demand will fall and vice versa, although there are exceptions to this where a high price is used to make a product appear more "exclusive". Businesses use the elasticity of demand to determine what price to set in order to maximise profitability. Some businesses operate within markets where the products are considered inelastic. For example, petrol is generally considered to be inelastic as if the price rises the demand is not affected greatly. This is because vehicle owners need petrol so the increase in sales would be greater than the loss in demand. Over the long term it is elastic as vehicle buyers will be encouraged to buy vehicles using alternative fuels, find different means of transport (e.g., train, bus) or better fuel consumption. Individual petrol stations are elastic as consumers will go where the prices are cheapest. Commodity products are also generally inelastic (e.g., bread). An example of elastic demand might be McDonalds in the fast food market. They are in a highly competitive market and raising their prices too high would lead to a loss in demand greater than the increase in sales. Businesses will raise prices as high as possible if it demand is inelastic until it is so high it becomes elastic, whereas elastic products should be lowered to gain better profits caused by increase in demand.