What is Price Sensitivity?

Explanation

This concept 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 price of the product. 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.read more could increase, decrease, or remain stable with a change in the cost of the particular article.

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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

Here,

  • 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 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 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 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.read more, 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.

Examples

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 companyFMCG CompanyFast-moving consumer goods (FMCG) are non-durable consumer goods that sell like hotcakes as they usually come with a low price and high usability. Their examples include toothpaste, ready-to-make food, soap, cookie, notebook, chocolate, etc.read more 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 changePrice ChangePrice change in finance is the difference between the initial and final values of an asset, security, or commodity over a particular trading period.read more 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.

Why is it Important?

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.

Factors Affecting Price Sensitivity

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

A few of the important ones are mentioned below:

  • One of the most significant factors in deciding price sensitivity is perceived value and competition. If the product faces 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.read more, 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.

Conclusion

Wrapping up, 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.

This has been a guide to What is Price Sensitivity & its Definition. Here we discuss how to calculate the price sensitivity examples using formulas and factors and why it’s important. You can learn more about from the following articles –

  • Unitary Elastic Demand DefinitionPrice Elasticity of SupplyDemand Curve ExamplesCalculate Cross Price Elasticity of Demand