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.

This concept is quite popular and useful in the business world because it delineates demand and price relationship to understand the consumer behavior, sensitivity, and value creation, and helps companies to launch or amend product prices or to create a valuable product or service to fit perfectly in the demand and price matrix.

• Price sensitivity is also known and calculated by the price elasticity of demand. It is a measure of change (in percentage) in the market for the product or service compared to the price changes. It is broadly used in business to decide product prices or study consumer behavior.
• This theory determines the change in product demand versus the price change. In addition, the quantity demanded may increase, decrease, or remain steady with a difference in the particular product price.
• It is an essential tool to obtain the product or service prices, understand consumer behavior in the market, and identify the value the customer requires and the company's product pricing. The price is called the equilibrium price. Therefore, the company analyzes changes in the product's price to know the effects on the demand for the product. 

The concept of price sensitivity analysis estimates the difference in the demand for the product vis-a-vis the change in the price. It shows the change in the demand with a variation in the product's price. For example, the quantity demanded could increase, decrease, or remain stable with a change in the cost of the particular article.

In other words, it helps in deciding how much the customer will pay or the producer will charge for a particular product. It helps in exploring the various methods and tools that may be used to the balance between in the market.

Since it helps in measuring the effectiveness of the price on the customer’s buying decision, it is a volatile concept. There are various factors that influence it very strongly. The types of goods and services the producer is selling, the buying capacity, income, preference and behaviour of customers, other market factors and the economy trends influence it to a large extent.  

Thus in this case, it is important to understand the relation between price sensitivity analysis and elasticity. A very high elasticity of demand means with a very minute change in the price of product, the demand level changes to a great extent, whereas a product with low elasticity will experience a very small change in the demand even though the price might change to a great extent.

This is turn brings us to the topic of price sensitivity in signifies how much the product is sensitive or responds readily to the change in price. It is very crucial for any business to keep track of this concept because it helps the entity to plan its production as per the changes in the market and the economic condition of the country. It helps in taking advantage of the changes in preferences of consumers.

The formula for calculating Price Elasticity is generally used to calculate customer price sensitivity and is mentioned as follows:

Price Sensitivity Formula = % Change in Quantity / % Change in Price

Here,

1. Change in Quantity denotes the alteration in purchased quantity by the buyer.
2. Change in Price means the increase/decrease in the price of the same product compared to its earlier price.

To proceed further, we need to understand Price Elasticity too. It is an essential tool in economics to derive the price and demand relationship. The price elasticity of demand calculates the customer price sensitivity of a product. It records the change that occurred in demand due to changes in the cost of the product. As per the law of demand, 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.

Let us look at some price sensitivity example to understand the topic.

Example #1

Calculate the price sensitivity of a service whose demand has fallen by 10% by an increase of 25%.

Solution:

Price Sensitivity = % Change in Quantity / % Change in Price

• = - 10% / 25%

• PS = - 40%

Example #2

Calculate the price sensitivity of the product of the company. Let’s assume that an FMCG company changes the price of orange juice, one of its brands, from $50 to $75, and the company observes a decrease in the demand for the product by 40% for that particular quarter. 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.

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 small change in the price could change the demand for the product powerfully. Thus, the above price sensitivity example help in understanding the topic.

It is an essential measure in deriving the product or services prices and understanding 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 modifications in the product's price to see effects on the demand of the product. The company could optimize its offerings and increase or retain its customer base through it.

Various factors could affect the customers' decision-making when the price of a product is concerned. The method of measuring 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 buyer's perception.

A few of the important ones are mentioned below:

• One of the most significant factors in measuring price sensitivity is perceived value and competition. If the product faces intense competition by the exact, similar, or substitute products, 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.
• Consumers are insensitive to the price of a product if it is unique or heavily differentiated compared to its peers. Products of brands such as Rolex, Ferrari, Louis Vuitton, etc., are comparatively expensive than their competitors, but still, they attract 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 oil price would not affect the demand for the product in a big way. Similarly, products that are addictive or placed higher in the consumer's habits are also less sensitive to price, and we could take up cigarettes or alcohol as examples.
• One more widely observed phenomenon is the buyer's perception of the quality of the product concerning 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 be 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, multiple constituents could affect the price sensitivity of a product.

This has been a Guide to Price Sensitivity and its meaning. We explain it with example, factors, how to calculate it and its importance. You can learn more about from the following articles –

• Unitary Elastic Demand Definition
• Price Elasticity of Supply
• Demand Curve Examples
• Calculate Cross Price Elasticity of Demand