Price Elasticity

Why this matters for your decision

If demand is inelastic, it barely falls when the price rises, and revenue increases. If it is elastic, a higher price loses more volume than it earns per unit. Whether a price change pays off therefore depends directly on elasticity, and elasticity differs by category, brand, price level and competitive environment.

A meta-analysis of 1,851 elasticities from 81 studies finds an average of minus 2.62 (Bijmolt, van Heerde & Pieters 2005): on average, sales volume falls by around 2.6 percent when the price rises by one percent. For your own decision, this mean value is only a frame of reference. The variation between products is large.

How it is measured

For existing products, elasticity can be estimated from sales data if there has been enough price variation. For new offers or prices that have never existed, this data is missing. That leaves surveys or a behavioural test.

In Horizon's behavioural test, each person sees exactly one price. From the measured purchase intent per price level, an elasticity for the tested range can be derived. Because each person sees only one price, there is no comparison between prices, which influences answers in surveys with several prices per person.

Example

A manufacturer tests a cordless vacuum cleaner at €299 and €329, a difference of ten percent. Measured purchase intent falls by 15 percent at the higher price. The elasticity in the tested range is therefore about minus 1.5.

Demand falls more than the price rises, and revenue per visitor falls slightly. Whether the higher price still delivers more contribution margin depends on unit costs.

Distinction

Willingness to pay describes the maximum price of an individual person. Price elasticity describes the reaction of total demand to a price change. A price threshold is a point at which elasticity rises abruptly.

Cross-price elasticity describes how demand for one product reacts to the price of another, for example between price tiers or relative to competitors.

Limits

An elasticity only applies to the range in which it was measured. Applying it to large price jumps assumes a smooth curve that often does not exist. It also changes over time, with competition and with the awareness of an offer.

A behavioural test measures the reaction of new prospects to an offer, not the reaction of existing customers or competitors. For products chosen on the shelf next to competing products, an offer page does not reflect the price reaction.