Before becoming another cog in the wheel of government in my home province three years ago, I helped pay my way through graduate school by taking on “sessional” positions at the local university teaching, among other things, introductory microeconomics. For the record, I loved teaching and if it had paid enough so that the poor buggers making a living digging tetra-pack out of dumpsters didn’t give me a sympathetic look, I’d have stuck with it. However, as sure as the Earth spins about the sun, we’d inch closer to a topic that many students dreaded more than the morning after a Jägermeister binge.
The topic? Elasticity. What is elasticity? Well, I’m so glad you asked.
**RED ALERT! SKIP AHEAD IMMEDIATELY IF YOU ARE PRONE TO BOREDOM, SUFFER FROM NOSE BLEEDS, ARE PREGNANT OR MAY BECOME PREGNANT**
Elasticity in economics is, put simply, a way to measure the responsiveness of one variable to changes in another variable. In economics it’s most familiarly encoutered in the context measuring how the quantity of a good demanded changes when prices are altered. Without getting into the nitty-gritty details and discarding silly academic curiosities such as Giffen goods, it boils down to three results:
- A good is considered “elastic” if its price is decreased by some percentage and the quantity demanded by consumers increases by more than that percentage
- We’ve got ourselves a good that is “unit elastic” if a percentage decrease in price results in a percentage increase in the quantity demanded that is of the same magnitude; and
- The good is “inelastic” if the price is decreased by some percentage and the increase in demand is less than that percentage.
Now, like all good students, you’re probably asking yourself, “Who the hell cares?”. Well, it’s because price elasticity has important implications for revenue and profit. And what matters more to a business than it’s bottom line. Amirite?
When producers of an elastic good increase price they see their revenues drop as people say “it’s too expensive” and trot off to find something else to spend their money on. Conversely, if producers dock their price, they see revenue rise as a lot of folks that were originally saying “it’s too ’spensive” open their wallets now that the price is more in line with what they’re willing to pay.
**NERDINESS HAS SUBSIDED! RED ALERT ENDS!**
In Edge there’s a feature titled Are Games Too Expensive? where Gabe Newell, El Presidente of Valve, gives the gaming world a lesson in economics with an example of just how price elasticity of demand works on a luxury good like video games! As it just so happens, when Steam offered holiday discounts on a whole bunch of games available through Steam, not only did the number of units sold jump through the friggin’ roof, but revenues shot up, too. Now, there’re all kinds of things that could explain the size of the increases, such as the “holiday effect” and “hurry up and buy before they jack up the price again effect”, but they saw this same phenomenon, albeit to a lesser extent, on other occasions as well.
What does it all mean?
Well, among other things, it means that games are an elastic good (duh!) and that if the change in revenues are reaching ridiculous heights when prices are dropped, then the price point for games is all wrong! Simply, they’re too expensive. As long as the higher cost of meeting demand doesn’t outweigh the increased revenues generated, Valve stands to make a few extra bucks. It’d take a bit of fiddling with prices and such, but somewhere in between what is charged now and giving it away for free, there’re additional profits to be found. And if one of the industry’s big wigs is saying “games may be too expensive”, perhaps it’s time that pricing were given another look.
