The law of demand says that there is inverse relationship between quantity and price. As price increases demand decreases, while a decrease in price will result in greater demand.
When the opposite happens, when higher prices actually increase demand, it is referred to as reverse elasticity.
For example imagine that you sell, on average, twenty $40 flower bouquets every week. This would generate $800 in revenue.
If you increased the price by 50%, to $60 you would probably expect to sell fewer bouquets due to lower demand at the higher price, and this would usually be the case. But in a reverse elasticity situation demand would actually increase and you would sell more bouquets at the higher price – increasing revenue on two fronts. If for example you ended up selling thirty bouquets (and increase of 50%) at the new higher price of $60 you would end up with revenue of $1800 – more than double the $800 you were making before.
It sounds great but seems totally counterintuitive... why would higher prices increase demand?
What does this mean to the seller? Does increasing price simply increase demand?. Unfortunately it's not that simple. Higher prices send a powerful signal about the desirability of a product and can increase demand but remember – reverse elasticity is a special exception to the law of demand. It is far more likely for demand to decrease as price increases, but the concept is worth exploring – take a look at the examples later in the article. There may be an opportunity for you.
Cause of Reverse Elasticity
Reverse elasticity is most often found in luxury goods and services – cases where decreasing price makes the product less desirable and lowers demand. People associate price with quality and a high price sends a very powerful message about the quality of a product. The idea of exclusivity, that only a few people can afford the product, make it more attractive still. Such products are often referred to as Veblen goods.
Real World Examples of Reverse Elasticity
Many excellent watches (attractive, reliable and accurate) can be found for less than $100, many more for less than $1,000. There is also incredible demand for watches that cost tens and hundreds of thousands of dollars. It is the high price and exclusivity that creates the demand.
It's not uncommon for members of high-end private clubs to complain about the high costs but without those high costs they would of course have little interest in membership. It is the high cost that makes the club exclusive and desirable. Many of the same facilities could be found at a public golf course or community center but such options are completely lacking in exclusivity.
Fine Wines, Premium Spirits
High prices not only increase demand by sending a signal about quality and creating an air exclusivity, they also have a real, measurable effect on the extent to which the product is enjoyed. There is hard data, taken from measurements of brain activity, that the people enjoy drinking a wine more when they believe it to be expensive.
Demand, like fortune, can favor the bold. A very successful florist once said that if he charged less than $100 for a dozen roses (probably double the average price at the time) his customers would ask what was wrong with them. The more he charged the greater the perceived prestige of his shop and demand for his products.
It's an enviable position, and one not every vendor finds themselves in. There are however enough advantages to offering higher prices (like the anchor effect) that you should look for ways to increase demand by increasing price.