Price Skimming

An introduction to price elasticity

Elasticity is a term widely used in economics in order to describe the way that something changes in response to another changing variable.

So, for example, that could mean how the sales of a product change depending on changes made to the price. This is known as price elasticity.

What is price elasticity?

The price elasticity of demand refers to how the demand for certain products or services responds to changes in price.

The price elasticity of a product usually depends on whether or not alternative products are available and, if so, how many. If consumers can easily replace a product with a different, cheaper option, the price elasticity of demand is very high. However, if the product is essential and cannot easily be replaced, the price elasticity will be low.

So, for example, increasing the price of product will usual result in decreased demand because consumers no longer want, or can no longer afford, to justify the spend. On the other hand, cutting the price of a product will typically lead to increased demand.

This is known as price-elastic demand because demand strongly depends on pricing, and will fluctuate in response to changes in price.

However, not all products and services follow this pattern. Essential goods, such as basic food products, housing, and medicines, must be bought regardless of the price. This means that demand stays stable even when pricing changes. This is known as price-inelastic demand.

Factors affecting price elasticity

The price elasticity of demand depends on a number of different factors, including:

  1. Availability of substitutes – Can the consumer purchase an alternative product for a cheaper cost?
  2. Cost of switching suppliers – Will the consumer incur additional costs and fees for changing suppliers?
  3. Degree of necessity – How essential is the product? Can the consumer cope without it or opt for a replacement? Is it essential or a luxury?
  4. Brand loyalty - How loyal is the consumer to a particular brand?
  5. Time frame when making a choice – How long does the consumer have to make a purchase decision?
  6. Percentage of income allocated to spend – Can they afford to spend more on the product?

Calculating price elasticity

Price elasticity can be calculated using the following formula:.

Percentage change in quantity demand divided by Percentage change in price

Remember, it is important to understand that the calculation is purely an estimate. Price elasticity can change over time, as markets change and consumers’ sensitivity to price changes.

What does price elasticity mean for stores?

For businesses, understanding how demand for a product might change in response to changes in price, is essential for creating an effective marketing strategy.

By calculating the price elasticity of demand for their products, businesses can gain an insight into how a change in price will impact the demand for their products. Not only is this useful for marketing, but it can also support other areas of the business, including finance and operations activity.

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