The term economics brings two things to a layman’s mind – demand and supply, as these are the two most commonly used terms in the world of economics. Although demand and supply are studied in detail under microeconomics, it still remains a part of macroeconomics in the form of aggregate demand and supply.
There are many other applications and concepts which are studied under demand and supply, the most common among them being elasticity. According to modern day economists, elasticity can be defined as the degree to which individuals, consumers or producers change their demand and supply patterns in response to changes in price or quantity. In the simplest form, elasticity is a measurement of percentage change in quantity demanded/supplied in response to a given percentage change in own price of the good.
When we study this topic further, we study another relatable concept known as cross-elasticity. Cross-elasticity of demand/supply is the responsiveness of the quantity demanded/supplied for a good to change in the price of another good. Over time, cross-elasticity has become the backbone of modern day demand and supply theories.
Demand and supply governs market conditions and cross-elasticity governs demand and supply patterns in the market. Here, I have tried to explain how cross-elasticity affects demand and supply patterns in the E-commerce industry.
Ever wondered how do big e-commerce service providing firms compete with one another? They certainly do not compete in terms of resources, assets, etc. in real time. The real competition is triggered by the prices of different goods and products available for sale on these e-commerce websites such as Amazon, Flipkart, Myntra, etc. Now suppose Amazon offers an Apple Mac book for 96,000 rupees whereas Flipkart offers the same for just 90,000 bucks, why would a normal consumer buy it from Amazon? Thus, prices are the real competition drivers in the e-commerce sector.
Next there comes another catch to the topic when we wonder whether how these firms determine their product prices after all. They follow a dynamic pricing strategy which enables the retailers to change their prices in accordance with consumer demand and competitor prices frequently. Moreover, sometimes they even follow dirty policies such as pushing competitors out of the market and then acquiring unsold stocks from retailers followed by skyrocketing of prices.
But all this still doesn’t answer one important question i.e. how do these firms compete with each other? This is where the phenomenon of cross-elasticity steps in. Change in price of good A on Amazon affects the price of good A on Flipkart too. Let’s try and understand this in detail with the help of the following example.
Suppose a customer Ravi wants to buy a Samsung mobile phone. Assessing the demand and supply conditions prevalent in the market these days, Amazon brings down the price of the phone from 18000 to 16000 bucks. Ravi buys the phone and lives happily ever after. No, this cannot end that simple as there’s more to come. We know about the inverse relationship between price and demand, which when applied here persuades us to believe that the demand for that very Samsung phone will now start to increase and Amazon will be able to attract in more customers, but what about Flipkart and Snapdeal? Will they just enjoy it all like a young couple enjoys a newly released Bollywood movie in a cinema? Of course not! They’ll have to take countermeasures otherwise Amazon will be able to capture a bigger share of the market.
So what they do is they lower their prices as well. Their new price may even go lower than 16000 bucks because they know that the law of demand has played its part by increasing the demand for that particular Samsung mobile and now is the right time for them to act. Eventually, elasticity steps in as owing to a percentage price change the percentage demand patterns of the commodity tend to change. Another thing that Flipkart and Snapdeal may resort to doing is affecting other demand determinants such as decreasing the prices of substitutes or increasing the prices of the complementary ones.
Another situation arises when suppose Amazon wasn’t able to analyze the market conditions accurately because of which it increased the price of a good whose demand was already nil. In this case too, other companies like Flipkart will bring down their prices or keep them unchanged as in the wrong experiment of price increase carried out by Amazon serves them with the possible destructive results it can deliver. This situation takes place rarely and is a bit complex too. So, we’ll not pay much heed to this right now.
What happens in the first example is that just with a minor change in price of a good by Amazon triggers its competitors such as Flipkart and Snapdeal owing to which they lower their prices as well, ultimately benefiting the consumers. The demand channel for that very product gets distorted owing to this very cross-elasticity phenomenon, causing the supply channel to boost its operations once and for all.
This is how cross-elasticity affects startup economics in the e-commerce sector. Cross-elasticity and its applications have many other complicated dimensions. This one discussed here is only a very basic idea about how cross-elasticity usually works.
So from now on, whenever you see an increase in price of a product on Amazon, don’t forget other e-commerce sites have your back!