By Dany Ortiz, on 5 July 2023
Information is power and, in the world of digital marketing, data is the fuel that drives it. This brings us to data science. Below, we will discuss the importance of data in understanding the impact of price variations on demand for your products or services, otherwise known as price elasticity of demand. By grasping the workings of this data and interpreting it correctly, you will gain insights into how prices affect your results and when it is advantageous to raise or lower them.
What Is Price Elasticity of Demand?
Price elasticity of demand is a formula allows you to tackle pressing questions that shape your pricing strategy. Will your customer base remain loyal if you raise prices, or will they gravitate toward your competitors? Understanding the price elasticity of demand enables you to evaluate the potential consequences of price adjustments.
Moreover, this data becomes indispensable when striving to meet specific revenue or sales targets. It empowers you to answer critical inquiries such as: How much should prices be adjusted to double sales?
In short, price elasticity of demand helps businesses be better informed and make better decisions regarding sales performance.
Price Elasticity of Demand Formula
To obtain the price elasticity of demand, simply divide the percentage change in quantity by the percentage change in price.
Thanks to data science, it is not necessary to do these calculations by hand to know the price elasticity of demand. It is enough to have a database with the historical prices of your products or services and sales. Data science algorithms will help you predict how the demand for a product will be altered if you implement any change (increase or decrease) in the price.
At Cyberclick, we have an expert data science team that can help you to get this information. Contact them and explain your objectives and get assistance.
Types of Elasticity
Before explaining the various types of elasticity, it is important to understand a fundamental concept: any result below 0 (negative) obtained from the aforementioned formula signifies an inelastic demand. In this case, consumers rely on the goods or services, and their demand remains relatively unaffected by price changes.
Conversely, any value greater than or equal to 0 indicates an elastic demand. This implies that if the price is altered, the demand will also undergo a corresponding change.
Unit Elastic Demand
In this case, changes in price will cause a proportional change in demand. For example, if you increase the price of your products by 10%, demand will decrease by 10%, and vice versa.
Perfectly Inelastic Demand
When applying the formula, the result of the price elasticity of demand is 0, which means that changing the price will not affect the demand for your product or service. However, it's worth noting that perfectly inelastic demand is relatively rare and typically associated with essential products or services that consumers cannot do without.
Relatively Inelastic Demand
In this case, there will be a percentage change in demand, but it will be less than the percentage change made to the price of the product. This means that, despite changes in price, there would still be people interested in the good or service. This pattern commonly occurs with necessary goods or services that are not essential, similar to the situation with perfectly inelastic demand.
Relatively Elastic Demand
This signifies that even minor price changes can lead to significant variations in demand. A notable example of this would be the hotel or tourism industries. Even a slight price adjustment, no matter how small, can prompt many consumers to seek more affordable alternatives or create a surge in immediate bookings.
Perfectly Elastic Demand
In the case of perfectly elastic demand, any small increase in price results in a demand of 0. Conversely, even a slight decrease in price leads to an exponential multiplication of demand. When demand is perfectly elastic, consumer demand for your product or service is the only factor influencing its price.
Variables Affecting the Price Elasticity of Demand
The more necessary the product, the more inelastic the demand will be. Essential goods or commodities, as mentioned earlier, tend to exhibit perfect or relatively inelastic demand. This means that regardless of how much the price increases, the demand for these products remains unchanged mainly because they are essential needs for the public.
Price of the Good vs. Consumer Income
The higher the price of the good, the more elastic demand tends to be. When the price is lower, demand tends to be more inelastic.
However, it is crucial to consider the context of your consumers' income. Customers with higher purchasing power are typically less sensitive to price variations (resulting in their demand being more inelastic or invariant). In contrast, customers with lower income levels are often susceptible to price variations, leading to more elastic or responsive demand. The income of consumers plays a crucial role in determining their sensitivity to price changes and the resulting elasticity of demand.
Existence of Substitute Goods
Substitute goods refer to alternatives that fulfill similar needs without being identical. For instance, margarine can serve as a substitute for butter. When substitute goods exist for your product or service, the demand tends to be more elastic.
The elasticity of demand is influenced by the time frame. Typically, demand becomes more elastic as time passes. In the short term, demands are often viewed as relatively inelastic. This is because when the price of a product increases, consumers may wait to react and explore alternative options.