SPLURGING WHEN TIMES ARE GOOD
"Americans spend all or most of their income on things that have little or no lasting value." – Thomas Stanley, The Millionaire Next Door author
Why do people splurge during good times? The answer to this question may be linked to the concept of price elasticity of demand.
This concept is one of the forecasting methods employed by economists in predicting the likelihood of an event occurring, which is based on the available data. When the price of a product or service changes by a specific percentage, they look at the corresponding percentage change in the quantity demanded of that product or service.
How? This article will outline four different scenarios encompassing supply and demand.
For example, you want to buy a PlayStation 4 for your spouse. Amazon sells five bundles of it. The four consoles cost $500 each, inclusive NBA 2K15 and DEAD OR ALIVE 5 Last Round. But the fifth one is sold at $600. How many consumers will pay the additional $100 to that console? Majority of rational consumers won’t spend more for a PS4, not to mention it does not come with freebies. On an average, a PS4 game costs approximately $40. This scenario depicts a perfectly elastic demand. The demand for PS4 will decline to almost zero with any price hike.
From perfectly elastic demand, here is relatively elastic demand. It pertains to the quantity demanded of a product or service will be influenced by a price change in that product or service. A product or service normally has high price elasticity when several substitutes exist. For instance, you notice different kinds of rock salt products in a grocery store. Every sack of rock salt costs $8. What if the store decides to escalate its price to $12 per sack? How many persons are willing to pay $12 for that product if there are so many alternatives? As the price increases, the demand for salt decreases.
Theoretically speaking, the demand for a product or service remains constant regardless of the price. Individuals with terminal illness won’t mind paying a premium for a cure for their disease. Same thing with drug addicts. Did we mention most people would pay any price for a water supply? However, once commercialized, bottled water would be relatively price elastic since the supply of tap water is practically free and plentiful. That is perfectly inelastic demand.
Last is relatively inelastic demand. Gasoline is a classic example of this concept. Business and consumers alike need gas for their operations or daily use. Most of us rely on gasoline even though there is a movement towards alternative fuels, since they do not consider these substitutes practical. In other words, most individuals would spend money on it reluctantly. But there are exceptions. During the 2008 oil and gas bubble, prices soared to around $4.25 a gallon, so people demanded less for that. Nevertheless, gas is a relatively inelastic product.
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