Elasticity of Demand as Hiring, Negotiation and Management Tool
Shopping for anything in a supermarket, you are likely to buy more or more often when the stuff is discounted and less when the price rises. How much more or less, if any, is a measure of what economists call “price elasticity of demand”.
What’s interesting about the concept and psychology underlying supermarket price elasticity of demand are, as will be explained, its implications for and applications in the workplace, hiring, negotiation, management and even family life.
Gouging, or Gauging?
Strolling down my local supermarket aisle I see here and there a sprinkling of steeply discounted specially tagged items (with offer expiry dates)—“2 for 1”, “60% off” and the like. Your reflex response to these kinds of temporary discounts is probably the same as mine: “Wait, if they can still make a profit at these prices, how much are they gouging us the rest of the time?” or “If this is a ‘loss leader’ or a case of ‘bait-now-and-switch prices-later’, they’ve got to make up the loss later—gouged again, right?” The last thing to cross our minds is that the prices have been dropped because some of their costs have dropped and that the producer or supermarket is passing those savings on to us.
But, maybe steep price cuts are not (just) gouging techniques or signs of simple fairness; maybe they are gauging techniques—gauging our sensitivity to price, a.k.a., the “elasticity of our demand” for their stuff, in particular, gauging how much pain in the form of prices we can take before we buy so much less that profits decline. Maybe such use of elasticity of demand is a gauging technique that can be applied in the office, before or after hiring.
If products fly off the supermarket shelves after a steep price cut, it may reasonably be suspected, if not concluded, that we, as consumers, are very sensitive to changes in price for those specific items. If demand increases, but not by much or doesn’t increase at all, our aggregate demand for the goods is highly “inelastic”, e.g., as is our demand for salt, which tends to be relatively fixed irrespective of price, because we must have it, because there are no substitutes and because the amount we need on hand does not warrant hoarding it in huge quantities. Likewise, if our demand doesn’t decrease at least in proportion to price, it is relatively inelastic with respect to price hikes.
There is also the possibility that a “luxury” effect may kick in: In some instances, the higher the price, the higher the demand, because of presumptions of higher quality or socioeconomic status. Manipulation through price elasticity of demand may detect this effect.
Either way, the wonderful discounts can be statistical tools for and a preliminary to jacking up prices as far as they can be hiked without a downturn in profit margins and total profits.
For anybody interested (if not, skip this): Being a concept from Economics 101, of course “price elasticity of demand” has its own formula:
ED = [(Q2-Q1)/Q1]/[(P2-P2)/P1]
ED- Price elasticity of demand
P1 – Price before change
P2 – Price after change
Q1 – Quantity demanded before change
Q2 – Quantity demanded after change
So, suppose, for example, that with a 2-for-1 discount on a $1 item, demand jumps from 100,000 to 500,000, ED is (500,000-100,000)/100,000 divided by ($2-$1)/$1, i.e., 400,000/100,000 divided by 1, which is 4. If there were no change in the quantity demanded, ED would be 0.
An analogous formula applies for “elasticity of supply”—percentage changes in the amounts producers are willing to supply as the price they can secure increases or decreases.
Workplace Elasticity of Demand and Supply
Now, how on Earth could price elasticity of demand (or supply) have any relevance to hiring and on-the-job decisions? Start with its potential as a gauge of responsiveness to changes in incentives or disincentives.
First, think of the weekend work hours imposed on an employee as a disincentive. Then compare weekend work hours with the cost of a can of coffee—its price as a disincentive to putting it into your shopping cart (analogous to weekend work as a disincentive to accept or stick with the job).
Reduce the disincentive and you will increase the incentives to buy, relatively speaking. If the price of the coffee is manipulated to accurately and precisely gauge how much it can be increased without harming the bottom line, such a practice could translate into management and hiring strategies, by manipulation of the number of hours of required weekend work.
Other applications of price elasticity of supply and demand include these:
1. A manager decides to try to boost output by publicly praising the most productive employees in morning meetings. He does this for three months, but detects no change in productivity. From the standpoint of elasticity of supply of labor, employees are insensitive to increases in praise as a reward.
This suggests that if the manager wants to increase productivity, (s)he’s going to have to use a “currency” other than or combined with praise (unless the praise has been so faint as to seem negligible to the employees).
If (s)he assumes that the supply of productivity must be elastic with respect to some “price” for those increases, it may be possible to identify which rewards will work better than praise, given the conviction that they must exist. For starters, pay raises may be considered.
2. A big corporation thinks multi-step interviews are the way to go, i.e., to have second and third follow-up interviews for all candidates. Apart from the information to be mined and honed, and despite the expense in time and effort for all concerned, the company believes it conveys an impression of “seriousness” on both sides.
Now, they are thinking of adding a fourth and final interview. But before adding that step, it might be wise to test it in several ways:
- Announce in a job posting that there will be four interviews and see how the response rates compare with ads that make no mention of the number of interviews and those that mention three, two or one. A spike in responses could mean that seriousness factor outweighed the time-cost factor for applicants keen to demonstrate how serious they are and to work for a serious company. A drop could mean that time costs and number of application hoops and hurdles as risk matter more to applicants than seriousness.
- Run the concept through a focus-group or stage-1 interview group that quantifies the participants’ likelihood of hypothetically or actually completing the application procedure for the job when there are 1, 2, 3 or 4 interviews. Treating the number of applications as “Q” and the number of interview steps as “P”, the results will translate into an elasticity of demand-for-jobs measure.
3. Another company experiments with salary offers the way a supermarket experiments with price discounts to gauge elasticity of demand—but in the company’s case, it’s employee demand for a re-negotiated employment contract offered by the company. Initially it low-balls the incumbent employees while advertising for new employees at the low salary figure (possibly the same as that of the previous contract).
It then increases the offer incrementally, noting what percentage of employees opt for renewal (something statistically feasible and credible in companies with huge or dispersed workforces).
With the final numbers of renewals tabulated, the company can calculate the elasticity of supply for employee labor and make extrapolations, e.g., to other branches or the future (with, of course, careful statistically-savvy attention to be paid to other influential variables, such as inflation or changes in other aspects of work load or compensation).
4. What about this radically different concept of probationary salary? Offer a time-limited, e.g., three-month higher starting salary (on analogy with a supermarket temporary discount) for the first dozen applicants actually hired. At the end of the period, reset the salary to a lower, more normal or “appropriate” level and note the employee retention rates.
Just as the supermarkets and their suppliers are hoping that familiarization, if not addiction, to the shelf product will sustain demand, the hiring company may enjoy a similar “brand loyalty” effect. In both cases, it’s a gamble—but, in any case, an instructive one.
Elasticity at Home
Taking the analogy with manipulative supermarket discount pricing a step farther, at work—and even at home—we always have to be vigilant regarding the possibility that we are being offered a temporary sweet deal that will ultimately have a sour outcome, in terms of eventual higher costs or disincentives. Even your kids could use calculated elasticity of demand to manipulate you.
For example, your tech-savvy teenage son tells you that he will teach you the basics of Photoshop if he can take his date to the prom in your vintage Ford Thunderbird. You accept the deal and are eager for more.
So he offers you a new deal: more Photoshop instruction if he can take the car out every weekend during the summer vacation. Without any conscious understanding of or performance of any calculations of elasticity of demand, he’s counting on your demand for Photoshop skills to have become strong and inelastic with respect to his “price” hike.
Just like your local supermarket and its suppliers.