What is Price Sensitivity?
Price Sensitivity, also known and calculated by Price Elasticity of Demand, is a measure of change (in percentage term) in the demand of the product or service in comparison to the changes in the price, and is used widely in the business world to decide the pricing of a product or in cases of studying consumer behavior.
It shows what would be the change in the demand with a variation in the price of the product. This concept estimates the difference in the demand for the product vis-a-vis change in the price. The quantity demandedQuantity DemandedQuantity demanded is the quantity of a particular commodity at a particular price. It changes with change in price and does not rely on market equilibrium. could increase, decrease, or remain stable with a change in the cost of the particular article.
How to Calculate Price Sensitivity?
The formula for calculating Price Elasticity is generally used to calculate Price Sensitivity and is mentioned as follows:
Price Sensitivity Formula = % Change in Quantity / % Change in Price
- Change in Quantity denotes the alteration in purchased quantity by the buyer.
- Change in Price means the increase/decrease in the price of the same product in comparison to its earlier price.
The price sensitivity of a product is calculated by the price elasticity of demand. To proceed further, we need to understand Price Elasticity too. It is an essential tool in economics to derive the price and demand relationship. As per the law of demandLaw Of DemandThe Law of Demand is an economic concept that states that the prices of goods or services and the quantity demanded are inversely related when all other factors remain constant. In other words, when the price of a product rises, its demand falls, and when its price falls, its demand rises in the market., in economics, if all the other relevant factors remain constant, an increase in the price of a product would be supplemented by a decrease in the demand for the product. It records the change occurred in demand due to changes in the cost of the product.
Calculate the price sensitivity of a service whose demand has fallen by 10% by an increase in the pricing by 25%.
Price Sensitivity = % Change in Quantity / % Change in Price
- = – 10% / 25%
- PS = – 40%
So, it is evident that the consumers are sensitive to price changes, and one percent of price change could affect 40% of the demand for the service. Let’s assume that an FMCG company changes the price of orange juice, on of its brands, from $50 to $75, and the company observes a decrease in the demand of the product by 40% for that particular quarter. Calculate the price sensitivity of the product of the company.
Solution: To calculate this, we need to apply the below-mentioned formula:
Here, we are required to calculate the % change in Quantity and that would be
(Updated Price – Earlier Price) / Earlier Price
- =($75 – $50) / $50
- = 50%
Now, this would be calculated as per the formula:
- PS = -40% / 50%
- PS = – 80%
So, we can see that the consumer of orange juice products is heavily price-sensitive, and even a smaller change in the price could change the demand for the product in a strong way.
Why it’s Important?
This is an essential measure in deriving the prices of the product or services, and to understand consumer behavior in the market. It is a crucial tool to judge the value required by the customer and the pricing of the product by the company. So it doesn’t hurt either party. The price is known as Equilibrium price. Thus, the company assesses or performs modification in the price of the product to see effects on the demand of the product. Through it, the company could optimize its offerings and increase or retain its customer base.
Factors Affecting Price Sensitivity
The price sensitivity varies from consumer to consumer and the value perceived from the purchase. Some products are highly elastic and some are low thus it depends a lot on the product offered and the perception of the buyer too. There are various factors that could affect the decision making of the customers when the price of a product is concerned.
Few of the important ones are mentioned below:
- One of the most significant factors in deciding the price sensitivity of a product is its perceived value and competition. If the product is facing intense competition by the exact, similar, or substitute productsSubstitute ProductsAny alternative, replacement, or backup of a primary product in the market is referred to as a substitute product. It refers to any commodity or combination of goods that might be used in place of a more popular item in normal circumstances without affecting the composition, appearance, or utility., then it will have the highest sensitivity. In the case of related articles, the buyer is highly sensitive and keeps shifting from one product to another. For instance, the consumer staple market has multiple brands, and if one company would increase the price, the consumer could shift to a similar product.
- The consumers are insensitive to the price of a product, if it is unique, or heavily differentiated in comparison to its peers. Products of brands such as Rolex, Ferrari, Louis Vuitton, etc. are comparatively expensive than its competitors, but still, it attracts more buyers. This phenomenon is quite visible in top luxury brands across the world.
- Few products such as gasoline are of high necessity, and an increase or decrease in the price of the oil would not affect the demand of the product in a big way. Similarly, products that are addictive or placed higher in the habits of the consumer are also less sensitive to price, and we could take up cigarettes, or alcohol as examples.
- One more widely observed phenomenon is the perception of the buyer upon the quality of the product in relation to the price paid. If a consumer or buyer perceives the quality of the product would be better, in case of higher rates, the sensitivity of such a product would below. In the case of mobile phones, where the offering of features increases with the price, it could be a fitting example.
- Apart from the ones mentioned above, some other notable factors could be the shared cost effect; end benefits offered, Trust factors, the quantum of expenditure, etc. So, there are multiple constituents that could affect the price sensitivity of a product.
Wrapping up, this concept is quite popular and useful in the business world because of its delineation of demand and price relationship to understand the consumer behavior, sensitivity, and value creation, and helping companies to launch or amend product prices or to create a valuable product or service to fit perfectly in the demand and price matrix.
This has been a guide to What is Price Sensitivity & its Definition. Here we discuss how to calculate the price sensitivity examples using formula along with factors and why it’s important. You can learn more about from the following articles –