Since the pricing strategy that you choose dramatically influences your profit margin, you must know your items’ price elasticity of demand. With the estimate of an item’s price elasticity, firms can figure out if a change in price will either positively or negatively impact sales revenue. By combining the price elasticity estimate with the item’s markup, you will be able to figure out if profits get affected by a change in selling price. As a result, using elasticity-based pricing is essential for increasing profit margins. But, what exactly is the price elasticity of demand?
Price Elasticity of Demand
The price elasticity of demand is the measurement of how changes in the price of a product will impact what the demanded quantity will be. As you can see, it is essentially just a way to understand how customers respond to changes in prices.
What Defines Demand Elasticity?
When it comes to determining demand elasticity, there are a variety of factors that you need to take into consideration. For example, if an item is a need, then you can expect the demand to be inelastic. Also, items with a price that is small in proportion to the income of the buyer will most likely be inelastic. On the other hand, products that are wanted rather than needed tend to be more elastic. Demand will also be elastic, the more substitutes there are. Time is yet another factor. For instance, if you have been driving around for a long time without a single gas station in sight, your demand for gas will be inelastic. After all, you will go to the first station that you see regardless of the price as your tank will need some juice if you want to continue your travels!
How to Measure Elasticity of Demand
To calculate the price elasticity of demand, you have to divide the percent change in quantity demanded by the percentage change in price. Keep in mind that since the amount demanded typically declines with price, you will notice that the price elasticity coefficient will usually be negative. However, an additional profit margin can also impact a decrease in purchases, among many other factors.
Inelastic items have a price elasticity that is less than one since a single product price increase produced a less than one, single product decline in demand. In other words, a price increase of a single product will cause an even more significant reduction in demand. Therefore, you will maximize your revenue when the price elasticity of a product is one. In this case, the product is elastic. Don’t forget that this coefficient is simply an index; therefore, it measures neither price nor quantities.
Why a Pricing Tool Can Help You
While calculating the price elasticity of demand only requires the use of a basic formula, the larger your product selection, the more complicated the task will be. In addition to the large quantity, there is also a considerable chance for error as humans are not perfect.
What’s more, is that this time-consuming task then leads staff away from focusing on more critical business matters. To combat these problems, you can take advantage of a pricing tool. For instance, with the help of tools such as Competera’s price optimization, you won’t even have to touch the data as it will process everything on its own.
Additionally, this pricing tool will be able to pinpoint any meaningful connections amid the demand and your items. On top of being able to figure out the elasticity, the pricing tool is also able to take into consideration pricing and non-pricing parts to unveil the most optimal price points. In other words, with the help of a pricing tool, not only will you have the time to focus on much more critical tasks, but you will also get access to way more useful information that you would not have been able to obtain on your own. This way, you will be able to boost your profit margin without having to make any calculations on your own.