An Economic Lesson All Creative Professionals Should Learn – Price Elasticity of Demand

One of the most challenging courses I took at UC Berkeley was economics. (An interesting side note: Laura Tyson herself was my econ prof). Many of you reading this probably took an econ class at some point in your life. And chances are, if you’re a frequent reader of this blog, you are most likely the kind of person who HATED econ. Believe it or not, I feel your pain. I hated econ too (and I was a business major). But, there is a basic economic principle I think all professional creatives need to understand: that is the price elasticity of demand (or PED).

Econ 101 Revisited

You most likely understand the concept of supply and demand. The greater the demand for a good or service, the greater the price. Additionally, the greater the quantity of a product or service, the cheaper the price. This is the concept of scarcity. The more scare (low quantity) a product or service is, the more expensive it will be.

PED measures the relative demand of a good or service based on the change in price or quantity. A relatively elastic good or service will have a large change in demand with a relatively small change in price. On the flip side, a relatively inelastic good or service will have a small change in demand with a regardless of the change in price. I will spare you the mathematical formula used to derive PED. But suffice it to say that normally, the PED value is a negative number (i.e. demand goes down as quantity goes up).

Examples:

Gasoline is a relatively inelastic good. When I arrived in the Atlanta area just over three years ago, the price per gallon in my town was $1.29. Today it’s about $3.50. Yet, despite a nearly 200% increase in price, I still fill up my tank whenever it’s empty. I would guess that most people do the same. Huge increase in price, yet small decrease in demand for good.

On the other hand, video DVD rentals have a very elastic price sensitivity. Due to the alternatives to view movies and entertainment online for free or relatively inexpensively, changes in price will have a significant impact on demand.

Education has become a very elastic good as well.

So what does that mean for you as a professional creative? You need to know how elastic or inelastic your industry is. Furthermore, on a micro level, you need to know how elastic or inelastic your specific services are. In your industry (e.g. wedding photography or videography, graphic design, etc.) how much business can you expect to gain or lose if you change your prices by 5%? 10%? 20%? And are you providing a service unique enough, yet still in great demand, that even if you changed your rates significantly, you would see little change in your business.

As I’ve written before, if you’re a commodity you stand a greater chance of your services being more elastic. So here are two questions you should ask yourself:

  • Am I providing a good or service that is actually needed (or at least perceived to be needed)
  • Am I creating a needed product or service that has a discernible difference from my competitors

As the competitive landscape evolves, and as the economy fluctuates, your answers to those two questions should ideally be “yes.” If not, you may need to re-assess and re-evaluate your business model accordingly.