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What Is the Price Elasticity Of Demand
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Price Elasticity Of Demand

What Is the Price Elasticity Of Demand

Definition of the Price Elasticity Of Demand

The Price elasticity of demand refers to the change in demand for a product based on alterations to its price. For example, if a popular productivity tool’s price increases within two years of its release, will demand for the product increase, decrease, or remain the same?

Some items are considered inelastic, as their prices and demand levels tend to stay the same. Elastic products, on the other hand, will experience noticeable shifts in demand based on repricing. 

However, changes in price may cause little to no drop in demand, especially for products deemed ‘essential’ by consumers. Gas is a good example here, as people rely on fuel regardless of gradual increases in cost (though a major spike would no doubt cause people to look for alternative modes of transportation).

Price elasticity of demand in SaaS

SaaS products may be elastic or inelastic. A company increasing the price of its tool may, or may not, see a drop in demand if there are more cost-effective alternatives available. 

But increasing costs is a common business practice, especially for new ventures with rising overheads. That’s why it’s vital to position a SaaS product as a unique, essential offering. Users should feel the product or service is worth any extra cost, remaining loyal to the brand in the long-term. 

That being said, demand for a product will be put at risk as competing items reach the market, and companies must bear this in mind when considering price changes.

General FAQ

How to calculate the price elasticity of demand?
Price elasticity of demand is calculated as (% Change in Quantity) / (% Change in Price) For example, if a product’s demand goes down by 25% and the price increases by 50% the price elasticity is (-25%) / (50%) = -0.5. On the other hand, if the quantity bought increases by 25% and the price decreases by 50%, the price elasticity is (25%) / (-50%) = -0.5. Price elasticity of demand is usually a negative figure, as this shows that as demand goes up, the price goes down. And as demand goes down, the price goes up.
What are the major determinants of price elasticity of demand?
The major determinants of price elasticity of demand include: - The cost of switching from one product to another - Whether the product is a necessity or a luxury - The range of similar products available - The cost of a product relative to the average customer’s income - Whether a product has become a habitual choice for shoppers
Why is it important to know the price elasticity of demand?
Companies have to know the price elasticity of demand as it helps them assign appropriate prices to their products, as those with elastic demand are viewed as more responsive to price changes. Demand for a product could change significantly depending on price fluctuations, and businesses need to understand this to avoid loss of revenue or their competitive edge in the future.
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