Price Elasticity means the effect of price change on the demand for a product or services. Its understanding is very necessary for solving queries regarding business assignments. Price elasticity is the measure of the relationship between changes in the demand of quantity of a good and the change in its price. The price sensitivity of a product or service when discussed uses price elasticity as a measure. The most commonly used formula for calculating the price elasticity of demand is:

Price Elasticity of Demand = % change in Quantity demanded / % change in Price

A product is said to be elastic when the change in price is small but the change in quantity demanded is large. On the other hand, a product is said to be inelastic if the change in price is large but the change in quantity demanded is small.

Interpretation of Price Elasticity:

If the price elasticity of demand is equal to zero, the demand is perfectly inelastic. It means the demand will not change when prices change. If the values are between zero and one, it shows that the demand is inelastic. It means that the percentage change in demand is less than the percentage change in price. When the value is equal to one, both demand and price are equal. Concluding this, when the value is the greater one, demand is perfectly elastic. It means that the demand is affected more by the change in prices.

Example:

The calculations of Price Elasticity of Demand can be illustrated with an example below.

  • If the quantity demanded a good increases 15% in response to a 10% decrease in price, the price elasticity of demand would be15% / 10% = 1.5. This change can be influenced by a number of factors like the nature of goods (whether it is the necessity; an inelastic demand or luxury; demand is more elastic) or the number of its close substitutes (which product can replace it in the market; more close substitute, demand is elastic).

Calculation of price elasticity greatly influences the pricing decisions about a product. Pricing is basically a process of determining the exchange value of a product. It is the monetary benefit which a manufacturer receives in lieu of the product he offers to the customers. Pricing depends upon various factors such as manufacturing cost, raw material cost, profit margin etc.

Factors Influencing Pricing:

There are various factors which influence pricing. These may be classified as internal and external factors.

  • Internal Factors: These factors include marketing objective of a company, product features, consumer’s expectations from the company by past pricing, position of product in product cycle, rate of product using pattern of demand, production and advertising cost, uniqueness of the product, production line composition of the company and the price elasticity as per sales of product. These internal factors depend upon the cost of manufacturing of the product. These costs include fixed and variable costs.
  • External factors: There are various external factors which influence the price of a product. These include open or closed market, consumer behavior for a given product, major customer negotiation, variation in the price of supplies, market opponent product pricing and price restricted as per any governing authority.

Pricing Decisions:

There are various pricing decisions depending upon the product and the market trends. These may be as follows:

  • Penetration Pricing Decisions: In this decision or strategy, a product is introduced in the market with low price. This is to increase the number of target customers. This helps to penetrate further in the target market.
  • Skimming Pricing Decisions: In this decision or strategy, a product is introduced in the market with a high price. This is to target upper segment of customers which have higher paying capacity and thus gets skimmed from the rest of the customer.
  • Discounts and Allowances: The demand can be increased by offering discounts in quantity, trade, cash, promotional etc.

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