Pricing

Price Elasticity: what is it and how can it be influenced?

October 21, 2019

Understanding the price elasticity of your product/service and how it impacts your sales and business strategy is crucial to building a responsive, successful company. In this blog we want to give you a quick refresh on price elasticity and price perception.

This formula is used to identify how a change in price affects the supply or demand of a commodity. If people still buy a product/service when the price is raised, that product/service is inelastic. A product/service is elastic when demand suffers due to price fluctuations.

For example, research shows that raising cigarette prices doesn’t do much to stop smokers from buying cigarettes, therefore making cigarettes an inelastic commodity. Cable television, however, is a very elastic product. As the price of cable has increased, demand has decreased as more consumers “cut the cord.”

Substitutions such as Netflix and other streaming services have made the cable industry elastic. There are also substitutions for Tobacco, but none that have affected their core consumer’s desire and ability to continue buying cigarettes.

Image 1: Inelastic Demand – a change in price causes a smaller proportional change in quantity demand.

Formula of Price Demand Elasticity 

% Change in Quantity / % Change in Price = Price Elasticity of Demand

Two Types of Elasticity 

  • Inelastic Demand – a change in price causes a smaller proportional change in quantity demand
  • Elastic Demand – a change in price causes a bigger proportional change in demand
Image 2: Elastic Demand – a change in price causes a bigger proportional change in demand.

If you sell 10,000 PVC pipes of 100 euro and then raise the price to 150 euro and sell 7,000 pipes, your elasticity of demand would be -0.88. This would be considered inelastic because it is less than one.

Broken down even further to include the calculation of percent change, this formula looks like:

((QN – QI) / (QN + QI) / 2) / ((PN – PI) / (PN + PI) / 2)

QN = New quantity (7,000)

QI = Initial quantity (10,000)

PN = New price (150 euro)

PI = Initial price (100 euro)

Our numbers plugged into this formula would be:

(7,000 – 10,000) / (7,000 +10,000) /2) / (150 – 100) / (150 – 100) / 2) 

Head spinning? Let SYMSON advice you on price elasticity and the optimal price.

What influences price elasticity? 

Researchers at the Ehrenberg-Bass institute for marketing science managed to find the key factors which influence price elasticity, and also the factors which are of lesser importance. 

Their research found patterns across brands, products, and countries, and some of their findings contradicted popular beliefs about price elasticity. Let’s go through the six main influential factors they found one-by-one:

1.If the cost is the same or higher than the cost of a market leader in a category, the elasticity gets higher as well. The point is not that the price itself matters so much, but the relative price availability, i.e. in respect to the category leader and to the round point (for example, $10). This means if you want to keep the demand of your product optimal, you have to take into account the brand strength of your rival. If you’re a follower in price, calculate the optimal price index relative to the leader.

2.It is commonly believed that the bigger the brand, the smaller elasticity their products will have.This is not always the case, because it also depends on the “commodification” and the product life cycle of the product. Here, the brand value is “diluted” because the quality of commodities such as pvc pipes is less or more the same for every brand. For products like this, the customers will buy a product which is less expensive or better promoted.

Image 3: the stage of the product determines the demand elasticity.

3. Nobody likes a significant increase in price, that’s why there is a rule of single-digit price increase (no more than 9,9%). If the price increases by 10%, consumers get nervous and buy significantly less.

4. The mass market has the highest price elasticity. In this segment, the price elasticity increases, if the price is 5% higher or lower than the medium price. However, in general the price elasticity is lower for the economy segment as well as for luxury goods, as they have a loyal customer base.

5. A highlighted discount works 1.5 times better than the discount or another promo which wasn’t highlighted (for example, with different color). The reduced price needs to be “red-labeled”.

6. Price elasticity is higher for the less recent buyers, as they know less about the brand quality and they choose what is cheaper or has a discount. On a similar note, price elasticity increases for those who are more price conscious, though they have the “threshold line” the lowest price at which they are buying goods.

So, price elasticity is the ratio between change in demand and change in price. The higher the elasticity, the more the price influences demand. Price elasticity depends on factors such as the medium market price, brand size, type of customer, type of product and maturity level of product. 

Sources:
A Quick Refresher on Price Elasticity (& How It Impacts Your Strategy), Hubspot
Buying brands at both regular price and on promotion over time, University of South Australia.
Price Elasticity Explained, Comptera