Price Elasticity as a Means of Identifying

¶ … price elasticity as a means of identifying a brand's competitors. The possibility of using the concept of price elasticity to identify a brand's competitors implies a relationship between the two brands (substitution), and between their relative elasticity (cross price elasticity). This essay explores those relationships.

It has been said of the law of demand -- that the higher the price of a good, the less that consumers will purchase -- that it is the "most famous law in economics, and the one that economists are most sure of." This law is so certain and so consistently observed because it effectively predicts consumer behavior. The law of demand is in fact one of the basic principles of microeconomics (Anderson, McClellan, Overton and Wolfram, 1997).

The law of demand also makes it possible to measure how the price of a product or brand affects the demand for it. The most commonly used method to measure consumers' sensitivity to price is known as price elasticity of demand, and is simply defined as the proportionate change in demand given a change in price (Anderson et al., 1997). When the price of a product goes up, and the demand for it falls off, demand for the product is elastic. Conversely, when the price goes up and demand remains unchanged, that demand is said to be inelastic.

Given the relationship between a brand's price and its elasticity, the single most important factor that influences elasticity is the availability of substitutes (Investopedia, 2011). When consumers perceive that product X can be used in place of product Y, the products are substitutes for each other. Therefore, they are considered to be competing products, because substitute one for the other.

So what determines price elasticity of demand? The more close substitutes there are in the market, the more elastic is the demand for a product; consumers can more easily switch their demand if the price of one product changes relative to another (A S. Markets, n.d.). Again, there is the law of demand affecting not just consumption of one brand, but consumption of substitutes, that is, competing brands.

Price elasticity of demand also explains the fact that price becomes more elastic when higher prices turn away many consumers, who can chose to buy something else that is less expensive. When a good or service has numerous substitutes, prices are more elastic and will change with demand. In fact, availability of substitution is often a better predictor of price elasticity than is demand. (Ellis-Christensen, 2011). This correlation supports the conclusion that price elasticity identifies a competing brand.

When the price of one product affects the demand for another, economists refer to this as the cross-price effect. Cross price elasticity measures the responsiveness of demand for product X following a change in the price of product Y. For substitute products, i.e. competitive brands, an increase in the price of one brand will lead to an increase in demand for the rival product. Cross price elasticity for two substitutes will be positive. (A S. Markets, n.d.). For this reason, we can conclude that price elasticity of a brand can be used to identify its competitors.