A company produces cigarettes which it believes have a low price elasticity of demand. What is meant by price elasticity of demand? What effect...

Price elasticity of demand measures how sensitive consumers are to changes in the price of a good or service. For example, regarding a product, such as a food item, a 30-ounce package of ground coffee of a certain brand may sell for approximately $15.00. The company may sell 200,000 units a month in a particular geographic location.

However, the company decides to raise its price in this region to $15.75 for a 30-ounce package. As...

Price elasticity of demand measures how sensitive consumers are to changes in the price of a good or service. For example, regarding a product, such as a food item, a 30-ounce package of ground coffee of a certain brand may sell for approximately $15.00. The company may sell 200,000 units a month in a particular geographic location.

However, the company decides to raise its price in this region to $15.75 for a 30-ounce package. As a result, upon studying sales figures for the next few months it finds that monthly sales have dropped to 160,000 units. This is a vivid picture of price elasticity of demand.  Many consumers have made it clearly known that they are balking at this price increase. Therefore, they are refraining from buying this company’s coffee with its new increased price. It’s apparent that these consumers have switched their allegiance to other less expensive brands.

Essentially, if the coffee company is experiencing a change in demand because of this somewhat modest price increase then this coffee product is deemed elastic. Its demand is dependent on its price and any changes in that price.

On the other side of this equation, this coffee product would be deemed inelastic if there were a big price change—if, for example, the coffee now costing $17.75 for the 30-ounce package and the demand staying the same at 200,000 per month (quantity sold monthly). It would be apparent that consumers are loyal to this brand because of its quality and also the lack of a comparable product, and a significant price increase would not change their buying habits for this particular coffee brand.