Why is price elasticity important?
Price elasticity can help you compare different pricing methods to accurately price and market your products and services.
For example, based on your industry and the products you sell, you can assume they're either elastic or inelastic and create a pricing strategy that reflects your brand.
Let's say you're an e-commerce business that sells luxury nightgowns. This is an example of an elastic product—if the price rises, you'll see a decrease in the quantity demanded. Conversely, you'll get an increased quantity demanded if the price drops.
So what does this tell you? Ultimately, it can tell you whether to increase or decrease your prices to stay competitive based on the profile of your target audience.
For example, if your target audience makes $50,000 to $75,000 per year, you can assume they're more likely to purchase your products when the prices are lower. However, you must also ensure this doesn't cost your business money.
If you can increase your prices without decreasing demand, it makes sense to do it. However, if your products are inelastic and a small price change leads to a dramatic decrease in quantity demanded, you should consider how it will affect your bottom line.
However, the price elasticity of demand is rarely perfectly inelastic or perfectly elastic. It's usually estimated using data on the change in the quantity demanded and the change in price over a given period of time.
This estimated price elasticity can be used to predict how price changes will affect the quantity demanded, which can help businesses make better pricing and production decisions.
Factors that affect price elasticity of demand
Several factors can impact the price elasticity of demand to determine the responsiveness and relationship between your price and quantity demand.
Here are a few things to consider when pricing your products that may affect whether demand is price elastic or inelastic:
Availability of substitutes
Your business likely has a lot of competition, and price changes can impact whether your customers stay or go.
For example, if you sell pet products for $50 per item, your competitor might sell similar items for $45. If there are alternatives or substitutes for your customers, it's easier for them to switch to the competition if you increase your price.
However, if there aren't substitutes, the price will be less elastic. For example, everyone needs electricity. If the price goes up, it's highly unlikely customers will prefer to go without it.
Necessity of the product
There are a few things many people need, like food and shelter, along with everyday items like gas. Items more likely to be considered necessities are less elastic than things customers might deem as "wants" instead of "needs."
For example, customers want coffee in the morning, but they don't need it. Therefore, if you increase your prices, you might see a drop in demand, especially for luxury items.
To understand the impact of price elasticity of demand, you have to account for how much time you allow for a response. The longer you give customers to respond to a change in price, the more significant the response.
For example, increasing the price of bananas might not affect people for weeks because not everyone buys bananas on the same day.
Meanwhile, decreasing your prices can take time for customers to realize and respond to them.
Proportion of income spent on the product
Your customers likely have strict budgets. If they spend too much money on your product due to a price increase, they probably won’t purchase it again, especially if cheaper substitutes are available.
In addition, price changes affect how much customers can buy and spend. For example, let's say you sell t-shirts. If the price increases from $10 to $20 and consumers only have $100 to spend, they go from buying 10 to 5 t-shirts, which impacts your revenue.
How important your product is compared to other items in a household budget will ultimately determine whether it's inelastic or elastic.
While some customers choose brands simply based on pricing, others are extremely loyal to certain companies, especially if you provide them with value.
For example, loyal customers might refuse to purchase clothing from any other brand if you sell high-quality clothing. Brand loyalty is crucial and can help you keep as many customers as possible, even if you change the price.
However, there are other factors to consider, especially if you have an elastic product prone to demand shifts when pricing changes.
That said, brand loyalty can help prevent customers from seeking substitutes, which can help you increase your revenue if you decide to raise prices.
How price elasticity can affect your business
Price elasticity can tell you whether or not to increase your prices based on the products you sell and your target market. You spend a lot of time deciding how to price your products and services to help you stand out without alienating your target customers, so you want to choose carefully.
Price elasticity varies by product and industry, but knowing how to calculate the price elasticity of demand can help you determine how price changes can impact your business.
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