When it comes to pricing, many firms struggle because the task is quite tricky. After all, the choice you make plays a significant role in how the company will do. Thankfully, though, if you understand price elasticity, your company has a much better chance of reaching its pricing objectives. Let’s break it down.
Defining Price Elasticity
As you have learned over the years, the price of an item or a service significantly impacts a user. However, aiming to have the lowest price is not always the best solution. Indeed, this could cause shoppers to turn away from the offer, lowering the number of items sold. With the help of price elasticity, you can figure out exactly how customers respond to prices. All you have to do is figure out if the item is elastic or inelastic before you establish a price.
Elastic items are those that are sensitive to changes in price. For example, products that are not necessities or that have many substitutes often fall under this category. Inelastic ones, on the other hand, aren’t influenced by price changes. For instance, if you are gravely in need of gas, you will visit the first gas station that you need regardless of the price because otherwise, you will not have the fuel necessary to continue your trip. So, how do you figure out the elasticity of an item or a service?
Types of Price Elasticity
Thankfully, calculating price elasticity does not require much brainpower. Indeed, just divide the percentage change in quantity demanded by the percentage change in price. Based on the answer, you can determine how elastic the item or service is.
If the item is relatively elastic, then any small change in price will significantly impact the demand. In this case, your result will be any number higher than one. You can say that something is perfectly elastic when a small change in price results in a massive shift in demand, which you will find are typically pure commodities. Unit elastic items, on the other hand, will be strictly equal to one. Therefore, any alteration in price will result in the same change in the quantity demanded. Items or services that are relatively inelastic are opposite to elastic ones. As a result, big changes in price will cause demand to only change slightly. In this case, the number that you get from the formula will be less than one. Those that are perfectly inelastic are items that shoppers can’t live without and that don’t have many different purchasing options.
Use this information to help you figure out how your firm is doing. For instance, if it is really elastic, then you will know that your item is a commodity in the eyes of your shoppers. As a result, you will be able to figure out how useful your marketing efforts are.
Even though you can figure out price elasticity with the help of simple formulas, the calculation becomes difficult when you have many SKUs. In addition, keep in mind that human-made error will always naturally occur, which is why it is best to choose alternative routes. Therefore, instead of assigning pricing managers this task, we recommend utilizing the help of price optimization tools. This way, pricing managers will find the time to focus on more critical business tasks, while the job will also get done much quicker and without error.