What is Price Elasticity?
Price elasticity, often referred to as price elasticity of demand, measures the quantity demanded for any given product in relation to the price set for that product. Price elasticity is used by companies to determine the different ways that consumers respond to price fluctuations of the products offered. It reflects the sensitive relationship between the demand for a product and any changes in its pricing. Although it makes sense to simply assume that people would be more likely to purchase products that cost less, and less likely to buy those that cost more, this is not always the case.
Harvard Business School professor, Jill Avery has observed, “Some products have a much more immediate and dramatic response to price changes, usually because they’re considered nice-to-have or non-essential, or because there are many substitutes available.” (https://hbr.org). Since factors such as those cited above will necessarily constitute a part of any marketing equation, calculating price elasticity can provide useful data for companies, influencing their decision-making about setting or changing the price of their products.
How is Price Elasticity Determined?
There is a straightforward formula used to calculate elasticity: Price elasticity = Percentage change in the quantity of a product demanded / Percentage change in the price of the product. The category of perfect elasticity refers to situations where small changes in price result in large changes in demand; relative elasticity describes a situation where small changes in price lead to large changes in the quantity demanded. Going back to Jill Avery’s observations, “A marketer’s goal is to move his or her products from relatively elastic to relatively inelastic. We do that by creating something that is differentiated and meaningful to customers.” (https://hbr.org).
Companies generally operate with the goal of making as much money as they possibly can. In terms of price elasticity, this translates to making their products as inelastic as possible, by continually increasing the demand. Some questions for a company to ask itself when factoring price elasticity might include: Is the product essential, or is it more of a luxury item? What is the nature of the competition? Are advertising campaigns effective? What are the production costs? How loyal are the customers? According to Canadian economist, Mike Moffat, price elasticity is “…a basic building block behind your pricing…for different customer segments will vary. Thus, your marketing, pricing, and bundling must vary. At the end of the day remember, pricing is a process that you must integrate into your company’s trajectory.” (https://www.thoughtco.com)
The Impact of Price Elasticity
It is important for companies to gather extensive levels of data concerning the ways in which consumers interact with the products offered. Learning about how buyers respond to changes in the price of their products is beneficial in crucial ways, such as predicting future sales, setting prices at specific points in time, and determining the most effective advertising campaigns. These considerations are key when it comes to launching new product lines, as well as in the continuation of products, often utilized in determining when might be the optimum opportunity to employ strategies such as special promotions or discounting.
In the words of data scientist, Vivian Guo, “Pricing, and more specifically your company’s pricing strategy, is the one area…that still contains a considerable amount of guesswork…Yet setting a price and communicating value shouldn’t be a blind man’s game.” (https://priceintelligently.com)