Business Tips 101: What is Price Elasticity of Demand?

Price elasticity is an economic concept that you should get to know. It is instrumental in understanding the 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 lower. Products that are affected in this way are often non-essential or luxury goods.

Working out the 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 in price.

For a product that increases 10% in price and sees a 10% drop in demand, its 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 for 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 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 be more inelastic, because the purchaser is not paying the final bill.