Price Sensitivity

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What is price sensitivity?

Price sensitivity is the extent to which the price of a product affects consumers’ purchasing behavior. In summary, this is how demand evolves with the evolution of product costs.

In economics, price sensitivity is generally measured using the price elasticity of demand, or the measure of the change in demand as a function of its price change. For example, some consumers are not willing to pay an extra few cents per gallon for gasoline, especially if a cheaper station is nearby.

When studying and analyzing price sensitivity, companies and product manufacturers can make good decisions about products and services.

Understanding price sensitivity

Price sensitivity can essentially be defined as the extent to which demand changes when the cost of a product or service changes.

The price sensitivity of a product varies according to the level of importance that consumers attach to the price compared to other purchasing criteria. Some people may favor quality over price, which makes them less sensitive to price sensitivity. For example, customers who are looking for higher quality products are generally less price sensitive than bargain hunters, so they are willing to pay more for a high quality product.

On the other hand, people who are more price sensitive may be willing to sacrifice quality. These people will not spend more on something like a brand name, even if it has higher quality than a generic store brand product.

Price sensitivity also varies from person to person or from consumer to consumer. Some people are able and willing to pay more for goods and services than others. Businesses and governments can also pay more than individuals.

At some point, demand will drop to near zero if it reaches a certain price.

Price sensitivity and elasticity of demand

The law of demand stipulates that if all the other market factors remain constant, a relative increase in prices leads to a decrease in the quantity demanded. High elasticity means that consumers are more willing to buy a product even after a price increase. Inelastic demand means that even small price increases can significantly reduce demand.

In a perfect world, businesses would set prices at the exact point where supply and demand generate the most revenue possible. This is called the equilibrium price. While difficult, software models and real-time analysis of sales volume at given prices can help determine break-even prices. Even if a slight increase in prices decreases the volume of sales, relative gains in income can compensate for a proportionately smaller drop in consumer purchases.

Key points to remember

  • Price sensitivity is the degree to which demand changes when the cost of a product or service changes.
  • Price sensitivity is generally measured using the price elasticity of demand, which states that some consumers will not pay more, especially if a cheaper option is available.
  • The importance of price sensitivity varies relative to other purchasing criteria, so quality can outweigh the price, making consumers less sensitive to price sensitivity.

Influences on price sensitivity

Price sensitivity emphasizes understanding of the competition, the purchasing process and the uniqueness of products or services in the market. For example, consumers are less price sensitive if a product or service is unique or has few alternatives.

Consumers are less price sensitive when the total cost is low relative to their total income. Likewise, total spending relative to the total cost of the final product affects price sensitivity. For example, if the cost of registering for a convention is low compared to the total cost of travel, hotel and food, participants may be less sensitive to registration costs. When expenses are shared, consumers are less price sensitive. People in the same conference can share a hotel room, which makes them less sensitive to the hotel room rate.

Consumers are also less price sensitive when a product or service is used with something they already own. For example, once members pay to join an association, they are generally less sensitive to payment for other association services.

Consumers are also less price sensitive when the product or service is considered prestigious, exclusive or of high quality. For example, an association may have a premium feature of its membership provided through its programs and services, making members less price sensitive to changes in membership fees.

Pricing strategy

There are a number of different factors that companies use to develop pricing strategies. These factors will separate consumers based on their price sensitivity. Businesses can use marketing and advertising techniques to get consumers to focus on the price towards other factors such as product offerings, benefits and other values.

This is common in the travel, tourism and hospitality industries. Airlines generally charge more for certain flights, especially on weekends, or for different classes of flights. Many business travelers are less sensitive to price changes.

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