Everything you need to know about taking advantage of price elasticity of demand!

When establishing a full-fledged retail pricing plan, the idea of price elasticity is very vital to keep in mind. We give you all you need to know about it so that you can establish the most competitive rates, earn client loyalty, and fulfill the company's objectives.

What is price elasticity?

Price elasticity of demand is necessary in order to determine the relationship between changes in the amount of a good demanded and variations in the price of that good. If the demand for a product does not vary when the price of the product changes, the product is said to be inelastic, and the opposite is true if the demand changes when the price of the product changes.

According to a recent study, British consumers spend an average of £258 more per year on particular brands than they do on unknown ones. There are certain price and non-price elements that encourage purchasers to spend more for certain items even when a less expensive option is available. The price elasticity of demand is the result of the interaction of several elements. Because of its precise calculation, businesses are able to raise their income while retaining high levels of client loyalty.

Price elasticity of demand: A mathematical formula and some real-world instances!

The underlying tendency is that when the price of an item rises, customers purchase less of that goods. This implies that, in the vast majority of circumstances, price elasticity is negative. Positive price elasticity suggests that an increase in price results in a rise in demand; this is a circumstance that occurs in the luxury category but on a very rare occasion. 

When analyzing elasticity, it is more typical to utilize solely positive values rather than negative numbers.

The following is the formula for estimating the price elasticity of demand!

Inelastic demand is defined as demand that has an elasticity larger than one, whereas elastic demand is defined as demand with an elasticity less than one. The greater the elasticity of demand, the greater the dependence of demand on the price and the greater the speed with which it may vary.

For example, if the price of inexpensive frozen vegetable decreases, customers will purchase more goods in the short term, although there will be no increase in the long term. However, if the price of gasoline increases, the volume of fuel purchased will most likely remain the same as before. As a result, demand for frozen veggies is more elastic than it was previously.

The formula for calculating the price elasticity of demand!

Assume you're in the middle of preparing pizza. Although a pizza costs $4, the demand for it exceeds the supply by 60 pieces a day. Demand jumps to 80 pieces when the price is reduced to $2. The following formula may be used to determine the price elasticity of demand.

Price Elasticity = (percent(%) change in quantity/percent(%) change in price)

The demand for pizza is inelastic because the resultant price elasticity is between 0 and -1, indicating that the demand is not elastic. In this case, the pizza maker will have limited flexibility in adjusting the price of the pizza.

What factors affect price elasticity?

There are a plethora of factors that influence the price elasticity of the demand curve. Several recent studies by the Ehrenberg-Bass Institute for Marketing Sciences have found that the price elasticity of a product is influenced mostly by promotion circumstances and brand perception, with the former being the more influential. On the basis of this and other research, we may develop the following hypotheses.

• It is also possible that elasticity will grow if the price of a product is equal to or greater than that established by the category leader. Furthermore, it is not the price itself that is relevant, but rather the relative affordability of the product: how it compares to the price of the leader in the category as well as to a round figure (for example, $10).
• The strength of competing brands must be taken into consideration by retailers in order to maintain the best possible level of demand. You should compute the best price index for your product in respect to the top product in the segment if you are following rivals' pricing strategies.
• The price elasticity of a brand is determined by how familiar its items are to its buyers. When the quality of goods produced by several producers is similar, as is the case with laundry detergent, the brand value of the product might be diluted. In this situation, purchasers choose for a product that is less expensive or more well-publicized.
• A significant rise in price has the potential to disrupt the price elasticity of demand. As a result, shops adhere to the one-number price increase guideline, which states that the final price cannot increase by more than 9.9 percent. Buyers are likely to be disappointed and purchase fewer items if the price increases by ten percentage points.
• Consumer goods in the mass market have the greatest price elasticity of demand. Price elasticity is often lower in the economy and premium categories, on the other hand, compared to other segments.
• The price elasticity of demand varies depending on the category of customers being considered. For example, it may be higher for frequent clients who are loyal to a certain product or service.

Although the list of assumptions above is not complete, it does demonstrate the complexity and wide variety of price and non-price elements that influence the elasticity of demand in a given market situation. Price elasticity cannot be effectively estimated if only underlying factors are taken into account.

How to categorize products according to their price elasticity of demand?

When it comes to addressing long-term strategies and assuring the strategic growth of a business, SKU-based pricing can scarcely be regarded as successful. Retail chains have no choice but to go to a portfolio-wide pricing level in order to reduce the danger of sales cannibalization and raise the perceived value of shopping for customers in order to remain competitive. 

In this instance, it is critical to split the assortment into groups based on the elasticity of their demand in order to ensure successful management. Generally speaking, the greater the price elasticity value, the more sensitive purchasers are to price changes. Making price decisions on individual goods is unlikely to help you maintain a pricing policy; instead, you must segment the assortment based on the elasticity of the full matrix at one time in order to keep your pricing policy in place.

In many businesses, there are several distinct sorts of classifications for commodities to be found. Amy Gallo's essay in the Harvard Business Review gives one of the most well-balanced categories of price elasticity yet developed. The following are the author's five zones of elasticity:

• Goods that are completely elastic: Even the smallest adjustment in price results in a huge shift in consumer demand. Basic commodities are goods that fall within this category and are frequently referred to as such.
• Goods with a high degree of adaptability: Price adjustments that are only marginally substantial can have a major impact on demand.
• Goods having linear elasticity: Any change in the price of a product results in the equivalent change in demand. In situations when the price elasticity is one, the price is elastic.
• Goods that are somewhat inelastic: Even a major adjustment in price is unlikely to result in a meaningful shift in consumer demand. Gasoline is an excellent example of such a product, as previously discussed.
• Goods that are completely inelastic: It is improbable that a change in price will result in a change in demand. Real-world examples of completely inelastic items are rare, but commodity monopolies provide as one example.