What is Price Elasticity of Demand?

Before you price your product it’s important to understand how sensitive your customers will be to price changes. This means getting an understanding of your market, your competitors and how price elastic it is. #smallbusiness

Price elasticity is an economic concept that you should get to know. It is instrumental in understanding demand for your product and the price you can set for it.

A price elastic product is one that experiences changes in demand as the price rises or falls. Some products are staples, and their price is inelastic. (Think things like bread or milk). People will buy these regardless of price fluctuations. When your product is price elastic, a price rise might prompt people to buy an alternative product or wait until the price is cheaper. Products that are affected in this way are often non-essential or luxury goods.

Working out price elasticity of demand

You can determine price elasticity of demand, using an equation. The equation takes the percentage change in demand and divides it by the percentage change of price.

For a product that increases 10% in price and sees a 10% drop in demand, their price elasticity of demand is negative 1.

Most products range between negative one and zero.

The pricing factors you need to understand

Here are the factors you should consider before increasing the price of your product:

• Are there substitutes to your product? - If people can easily switch to another product they may be price sensitive.
• Your customer’s budget - If the cost of your product represents a small percentage of your customer's budget, they may pay less attention to the cost.
• Need or a want? - If your product is a necessity, your customer will buy it no matter the price. But they may not feel very good about the price increase!
• Loyalty to your brand - The goal is to have people choose your product over your competitors on factors other than features and price. Boosting brand loyalty can help to reduce price sensitivity.
• Your buyer - If your product is usually purchased through an expense account, your demand may more inelastic, because the purchaser is not paying the final bill.

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With competition increasing in most sectors, understanding your price elasticity can give you the tools to pitch your product competitively.