Pricing is a crucial aspect of marketing and product development that contains considerable and calculated estimation. Phenomenal marketing and product development can lead to an increase in your prices while maintaining the same level of conversion. These two areas of your business can also tank your conversion if done incorrectly. Setting a price and its optimization while communicating value shouldn’t be a shot in the dark.
How To Measure Consumers’ Reactions To Price Changes
If you sell something, how do you decide how much to charge for it? One way is to look at the price elasticity of demand. Price elasticity of demand is a measurement of how consumers react to changes in price. In other words, it can tell you how responsive consumers are to fluctuations in price, as opposed to price elasticity of supply, which determines the responsiveness of suppliers to price.
If an increase in price causes less of your product to be sold, that is called inelastic demand. When the quantity demanded of a product changes dramatically with even a small change in price, economists describe the product as elastic (or responsive to price changes). Something is deemed inelastic if large changes in price are accompanied by small amounts of change in demand.
Do more expensive products really sell less?
You may assume that the more expensive a product is, the less you buy of it. The less expensive a product is, the more you buy of it. This isn’t always true, though, because sometimes people don’t buy as much of a good even when the price gets cheaper. Perhaps they bought more than they needed when the price was high, or perhaps they switched to buying a similar good that is cheaper.
What is the Price Elasticity Formula?
Calculating the price elasticity of demand is not a terribly difficult task, once you understand how to do it. The basic formula is as follows:
Price Elasticity of Demand = (% Change in Quantity Demanded)/(% Change in Price)
If a good’s price elasticity is less than one, it is considered inelastic. When a unit increase in price results in less than a unit decrease in demand, the good is considered inelastic and when there is an even greater drop in demand following an increase in price, the good is highly elastic. Theoretically, total revenue will be maximized when the price elasticity of a good equals 1—in other words when demand is unit elastic.
When it comes to pricing, understanding this formula of price elasticity is key. By making your product offering more inelastic through marketing and product development, you can increase demand. Price elasticity of demand (the percentage change in quantity demanded divided by the percentage change in price) is almost always negative since the quantity demanded usually decreases with a price.
Ways Of Contributing To Increased Revenue
Economists express the price elasticity coefficient as a positive number even when its meaning is the opposite. This can be confusing, but it’s important to remember that a decrease in quantity demanded does not automatically mean that revenue decreases; additional profit margin can make up for slight decreases in purchases. If people buy things but at a lower rate and for less money, then how does a company earn as much money as before? They add a higher markup or profit margin.
One of the advantages of having a price-inelastic product is that revenue can be boosted by increasing price. If a product has high differentiation, it makes sense to increase the price, because consumers will still see the product as being different from rivals.