Price Elasticity: Understanding Supply and Demand

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  • 0:05 Being in Demand
  • 1:00 Supply and Demand
  • 2:15 How Supply and Demand…
  • 3:44 Elasticity of Demand
  • 5:00 Lesson Summary
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Lesson Transcript
Instructor: Jennifer Lombardo
Marketing managers need to understand the basics of supply and demand in order to develop the precise price for their product. Inelastic and elastic demand explains how sensitive consumers are to price and how much flexibility it allows the marketing team.

Being in Demand

The toy company Plastic Junk R Us has a new, fun product called Wiggle Worm Squirm. The company believes it will be really popular with the preschool set. A price needs to be established so the factories know how much to supply to the stores. Marketing managers must take time to set the correct price for their products to reach pricing goals established by the company. The marketing department must take into consideration the demand for the product and the cost to the seller for the product.

Demand is the quantity of a product that will be sold in the market at various prices for a specified product. In general, a higher price will result in fewer products being sold. Also, a lower price will result in more products being sold. The trick is for Plastic Junk R Us's marketing team to understand how both supply and demand interact. For this, the team is being sent to a pricing boot camp!

Supply and Demand

Example of a supply and demand chart
Supply Demand Chart Example

The predicted demand curve for Wiggle Worm Squirm can be best illustrated through a supply and demand chart. Supply is the quantity of a product that will be offered to the market by a supplier at various prices for a specified period. For example, a toy priced at $10 will result in a demand result of 2,000 units. If the price increases to $15, the demand from consumers will drop to a sale of only 1,700 units. Conversely, if Plastic Junk R Us prices the Worm at $8 a unit, the demand will increase to 3,000 units.

The Wiggle Worm Squirm might be sold at a lower price to try and bring in new customers. It will result in less profit due to the lower price but more volume of sales. So, the volume of sales will make up for the lack of profit. But, Plastic Junk R Us wants to sell their product at the highest price that consumers will let them. After a quick round of supply and demand basics at the boot camp, the team now heads into a strategy session on how supply and demand helps establish prices.

How Supply and Demand Establish Prices

So far at the pricing boot camp, the team has learned that if the price is X, then the consumer will purchase Y according to the supply and demand chart. Now, the team needs to analyze how high or low purchases will go for Wiggle Worm Squirm. The supply and demand curve needs to be combined to find the right price. According to the demand-supply chart, the price equilibrium needs to be established. This is the price at which demand and supply are equal.

The circled point on the supply and demand chart shows the price equilibrium for the product.
Supply Demand Price Equilibrium Chart

For example, the team is considering a price of $25 for the Wiggle Worm Squirm. At this price, 10,000 Wiggle Worms are demanded and 10,000 are supplied. Anything below the equilibrium, such as $20, will result in a product shortage, because at that price, the demand for the Wiggle Worm is greater than the supply. Shortages of products usually cause a price increase. So, eventually the price edges back up to $25 a Worm.

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