Here’s a simple and effective investment strategy: invest in companies that sell products with growing inelastic demand.
Let’s unpack what that means.
The price elasticity of demand for a product is the degree of responsiveness to which the demand for a product changes with respect to price. If the total demand falls/rises 20% for a price increase of only 5%, the product is price elastic. Think of travel or luxury items in this category, because their consumption rises if their price falls to a greater degree than the proportionate change in price.
But if the demand for a good is price inelastic, then the change in proportionate demand is much lesser than the proportionate change in price. So wild swings in price changes do not translate to wild swings in the demand for the product. This means two things:
1. Producers can charge whatever they want
If demand is going to fall 2% when you raise prices by 20%, you can maximize profits by charging a much higher price.
2. The product is a necessary good
For instance, oil. Oil prices crashed over the past four weeks, and when they went negative, you could’ve been paid to accept delivery of oil barrels. Just because it’s cheap didn’t mean everyone wanted more of it. Similarly, if oil prices suddenly rise too much in a day, all else being equal,
we won’t suddenly be reducing our consumption, and hence the demand, for oil.