One of the challenges that a business faces is determining at what price to set their products. While the business will often almost certainly wish to set the price high enough so that sales of the product will cover capital cost, it must take into account the relationship between price and demand. While price and demand are usually inversely related, this is not always the case.
Relationship of Demand and Price
Generally, the price of a product and the demand for it are inversely related. This means that as the price of the product goes down, the demand for it goes up and vice versa. This is in keeping with common sense: as a product becomes less expensive, more people will likely want it. However, sometimes demand will not rise much when a price drops -- and, in some instances, it will even fall.
The degree of change in demand for a product due to changes in its price is known as the product's price elasticity. If the product sees large changes in its demand based on relatively small changes in its price, then the product can be said to be an elastic product; if the changes in demand are small, then the product is inelastic. An absolutely inelastic product would be one that sees no changes in demand after a change in price.
In some cases, a product may be purchased by the same group of people no matter what the price. For example, if a group of sick people need a life-saving medicine to live, all of them may purchase it from the medicine maker, regardless of how much it costs. If the price of the medicine was dropped, demand would not increase, as no additional people would need the medicine.
In some cases, a drop in price may actually cause demand for a particular object to drop. For example, many luxury goods, particularly fashion items, are relatively cheap to produce, but are priced high to make them appear more valuable. If the price of the object were to drop, demand might drop, too, as consumers perceived the object as being less valuable than when it was priced more expensively.
- "Economics"; Roger A. Arnold; 2009
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