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Price Elasticity

Disciplines > Marketing > Pricing > Price Elasticity

Description | Example | Discussion | See also

Description

Price elasticity is the degree to which sales will go up or down as you increase or decrease the price.

A price-elastic product is one where you can change the price and sales will not change much, at least within a price-elastic range. A price-inelastic product is one where a slight change in price will result in a noticeable change in sales quantity.

Price inelasticity suggests a market where customers are price-sensitive, buying less product as the price increases. Other possible reasons for price inelasticity include:

• The product is not essential
• There are alternatives to the product, typically from competitors
• Customers are not loyal to the product or brand
• Customers are careful with their money and may have very limited funds

A price elastic market, where prices may change without much change in sales, suggests the reverse of this, so:

• The product is essential
• There is either a monopoly (one supplier) or oligopoly (price-collaborating suppliers)
• Customers are loyal to the brand
• Customers are wealthy or do not care about price

Example

A soap manufacturer increases the price of a bar of soap by a penny. Their sales go down slightly but their overall profit goes up.

A coffee company does price experiments in stores across the country in order to find the best price point.

Discussion

The basic principle of price elasticity is that there is a non-linear relationship between price and sales. Even when customers seem less sensitive to price, there will always be low and high prices where they would change how they buy.

It would seem logical that all you have to do is change your prices for a while to find the 'sweet spot' where sales or profits (depending on your market strategy) are maximized. However, customers are autonomous agents who change how they behave depending on how you change the price of the product. For example if you put the price down, they may think 'Great, it's cheaper', then when you put it up to the original price, some would not buy again as it now seems more expensive.

Price elasticity also depends on a range of other factors, such as how well-off the customer is feeling at the moment of purchase, which can simply be based on how much cash they are carrying at the time. It may also related to national or local economics, job prospects and so on. Another consideration is that the extent to which an item seems 'essential' can be determined as much by fashion and social factors as basic survival.

Price elasticity is more difficult to determine when products are bought less often. For example we buy televisions rather infrequently and face a wide range of different sizes, features and so on that can swamp much of our sensitivity to price. We typically do have a price range in mind, though may be tempted upwards by clever marketing and sales (or give up in confusion and just buy a cheap model).

A good understanding of price elasticity typically requires a careful statistical study. Experience can also be useful, for example where sales people have useful knowledge about how strongly customers focus on price rather than other factors. Sales can also give useful information, for example by observing how many extra sales are gained for known reductions in price. When you do have to put the price up, this will also tell you something about price elasticity, though initial customer reaction may calm down when they get used to the new pricing.

See also

The Price-Quality Graph and the Fair-Value Line