Price Elasticity of Demand: Know When the Price Is Right

Prices for gas, groceries, gadgets, and utilities consistently go up and down. In response, people might adjust their spending to skip getting a new gadget while paying more for utilities. That's a real-world example of price elasticity of demand — how sensitive customers are to price changes depending on what you’re selling.

The fundamental principle that prices fluctuate based on supply and demand helps businesses pinpoint the right price for their offerings. It also supports key sales functions like revenue lifecycle management, profit optimization, and improving customer satisfaction.

Price elasticity has a straightforward formula that unlocks effective pricing strategies and revenue forecasts. Let's dive into the key concepts, calculations, and use cases.

Price elasticity of demand (PED) measures how sensitive customer demand is to changes in price. It helps businesses determine if raising prices causes customers to buy less or if lowering prices leads to increased demand — potentially requiring more inventory or supply.

You can use a formula that calculates the percentage change in the quantity demanded or supplied and then divide that by the percentage change in price. The result shows a correlation between your price change and the amount you sold.

Using sales analytics software can give you deep insights into your pipeline. See where and why a deal is stalled, and your audience's sensitivity to any sale or price hike.

Price elasticity of demand vs. price elasticity of supply

You can measure price elasticity of demand or price elasticity of supply (PES). Here's a look at the formulas:

• PED = percent change in quantity of goods or services bought / percent change in price
• PES = percent change of supply of goods or services produced / percent change in price

PED and PES focus on different sides of the market equation. The key difference is that demand elasticity relates to buyer behavior while supply elasticity relates to seller responsiveness. Both are crucial for understanding overall market dynamics and making informed decisions about pricing, production, and investment.

Price elasticity of demand tells us how much the quantity demanded will decrease (or increase) when a product's price rises or falls. For example, if the price of coffee doubles and sales drop dramatically, coffee has high price elasticity of demand.

Price elasticity of supply measures how responsive producers are to price changes. For example, if the price of wheat goes up and farmers can quickly plant more crops and supply more, wheat has a highly elastic supply.

Understanding price elasticity isn't just about setting prices; it's about unlocking potential. PED helps with sales forecasting. You won't be caught off guard by a sudden dip in demand because you adjusted your prices. You'll ride the highs of an accurate financial plan that can boost profitability. PED helps identify who in your target market may respond differently to price changes. You can then decide to change marketing strategies or increase sales efforts. This allows businesses to make informed decisions by:

• Setting optimal prices: Businesses can use elasticity to figure out the price that maximizes their profits. For example, if they know demand is elastic (meaning a small price increase leads to a big drop in sales), they might keep prices lower to attract more customers.
• Planning for promotions and discounts: Knowing elasticity helps businesses decide if a discount will boost sales or reduce their profit margin. If demand is inelastic (meaning price changes have little effect on sales), a sale might not be worthwhile.
• Developing product strategies: Elasticity can help businesses understand how much customers value a product's features. If a key feature has inelastic demand (people will buy it regardless of a price increase for that feature), the business might focus on emphasizing that feature.
• Understanding customer behavior: Elasticity predicts how customers will react to price changes. This can be crucial for planning marketing campaigns, aligning your sales funnel, and budgeting.

Price elasticity of demand lets you determine how much you can increase prices without losing too many customers. You can create a marketing plan that targets customers who are willing to pay a premium for your products. This can include targeted advertising, promotions, and other strategies to increase sales and drive growth.

The ultimate goal for a business is to achieve inelasticity, where no matter the price change, demand stays the same. However, certain factors determine the inelasticity or price elasticity of demand for your product or service.

There are three main types of PED, each reflecting how strongly buyers react to price changes:

A slight change in price causes a large change in quantity demanded. Examples include luxury items, nonessential goods, or products with many substitutes (like designer shoes or gourmet chocolates).

The percentage change in quantity demanded equals the percentage change in price. For example, if a 10% increase in price results in a 10% decrease in demand, demand is considered unitary elastic. This is uncommon but important for understanding balanced pricing effects.

What's the difference between unit elastic and elastic? Unit elasticity is a one-to-one ratio. Increase the price by 25%, and you see a 25% change in demand. In contrast, simple elasticity doesn't carry as much of a direct correlation.

A change in price causes only a small change in quantity demanded. Buyers still purchase about the same amount regardless of price fluctuations. Essentials such as medication, gasoline, or staple foods often fall into this category.

Four factors directly influence how customers respond to pricing. You need to consider what your audience finds urgent or essential. Then, be ready to adjust your pricing accordingly to meet their needs. Let's go through each element in detail.

If your product or service is nonessential, like ice cream, customers may feel less compelled to buy at your set price and could look for a more affordable option. But for essential items like medicine, options are limited between generic and name brand, and once people find a product that works well for them, it's hard to get them to switch.

Are there limited substitution options for your product? Or can customers find a variety of sellers that provide similar goods and services? Let's go back to ice cream. You can go to any number of diners, shops, or grocery stores to get your favorite scoop. If something is nonessential and competition is plentiful, then you need to pay attention to price elasticity.

How long a product or service is priced at a certain amount affects demand. The longer the price change lasts, the more likely people are to find ways to adapt, which can lead to a bigger impact on demand.

Think about a surprise one-day sale. You might be caught off guard and then adjust by grabbing a discounted item you like, but this won't change your overall shopping habits. A more permanent price increase gives you more time to prepare, allowing you to find alternatives or adjust your budget. AI sales agent software can help your team predict your customers' reactions and provide coaching around how to address any concerns that could hinder a deal.

If your product's price takes a large chunk out of your customer's wallet, even the slightest increase could immediately affect demand. By the same token, if your prices are a smaller fraction of the customer's income, a price change will have less impact.

This is evident with enterprise resource planning (ERP) software, which often carries a hefty subscription fee. When the ERP subscription price rises, businesses must seriously consider whether to stick with their current provider or switch to a competitor. You can use a sales engagement platform to develop personalized messaging that explains to your customer the benefits of your product despite the price change.

Keep all these factors in mind when setting or adjusting your product or service prices. After evaluating all potential scenarios that could influence your price elasticity of demand, it's time to categorize your products or services.

As mentioned, the formula for price elasticity is:

percent change in quantity of goods or services bought / percent change in price

Let's put the formula into action and take it step by step.

Say your ice cream shop sold 150 cones at $1 each yesterday. You decide to raise prices by 75% making the new price $1.75 per cone. Today, you only sold 125 cones.

• Formula: (new quantity – original quantity) / (new quantity + original quantity) / 2
• Example: (125 – 150) / (125 + 150) / 2 = -.045 (or -4.5%)

• Formula: (new price – original price) / (new price + original price) / 2
• Example: ($1.75 – $1) / ($1.75 + $1) / 2 = .136 (or 13.6%)

• Formula: percent change in quantity / percent change in price
• Example: -4.5% / 13.6% = -.33

After the calculations, you'll be left with either a value greater than 1, a value equal to 1, or a value less than 1.

• Greater than 1: Your product or service is elastic. When you change your price, you will see a significant proportional change in your supply or demand.
• Equal to 1: You've achieved unit elasticity. When you change your prices, they will be equal to your change in supply and demand.
• Less than 1: Your product or service is inelastic, and any price changes will be relatively small in proportion to the shift in your supply or demand.

Managing price elasticity of demand is about strategically shaping how customers perceive value. The goal is to make your offering so valuable, trusted, or convenient that customers become less sensitive to price. Here are five ways to do that, along with real-world examples to illustrate each one:

If your product stands out, customers are less likely to compare it directly with cheaper alternatives. Be sure your sales team unites on messaging. Sales productivity tools can break down silos and allow real-time visibility into customer communication and deal progress.

• Example: High-end electric vehicles differentiate themselves through innovation and a distinctive brand identity. Like many luxury products, their points of differentiation include an elite lifestyle filled with the latest technology and an environmentally friendly car.

Loyal customers don't just come back. They defend your pricing, forgive your mistakes, and ignore your competitors.

• Example: Upscale coffeehouses use rewards programs and consistent customer experiences to retain a loyal base, even though their coffee often costs twice as much as competitors.

Instead of discounting blindly, use tactics that match perceived value with what each segment is willing to pay.

• Example: SaaS companies use freemium and value-based pricing models, allowing customers to upgrade as they grow or require additional features.

The way you introduce price changes matters. Transparency and how you frame it can have a significant impact. Software like Agentforce can help improve customer engagement by delivering the news of a new price change in a way that positively resonates with your customers.

• Example: Video streaming services announce price increases in advance, framing them as necessary to support more original content.

Because not all customers respond to price changes equally, tailoring your offers for different segments helps maximize revenue and minimize resistance. Using AI for sales can unlock critical relationship insights that influence how you create your outreach.

• Example: Hotels provide corporate rates, early-bird discounts, and loyalty member benefits — all aimed at attracting demand from various segments.

By managing PED through strategic differentiation, brand loyalty, intelligent pricing, and segmentation, businesses can shift the focus from price to value. This allows for more profitable growth, even in price-sensitive markets.

Businesses that clearly understand their customers' needs and motivations can shape demand, protect profit margins, and increase revenue even in competitive or price-sensitive markets. You can use Salesforce automation software to access historical customer data and analyze price elasticity for different groups, as some segments may be more sensitive to price changes than others.

The standard formula makes calculating the price elasticity of demand straightforward. You're now better equipped to choose the right pricing strategy and forecast more accurately.