[Strategy]-[$Pricing]-Price Elasticity
Price elasticity provides a standard way to predict quantity reactions to price. Also, it enables us to better understand the competitive structure of the marketplace.
Price elasticity is a measure of how sensitive quantity demand is to a change in price.
Cross price elasticity is measuring the sensitivity of my demand to changes in someone else’s price. The cross price elasticity could be the quantity that I sell react to the price changes that maybe one of my competitors, or maybe another complimentary product may be setting in the marketplace.
Cross price elasticity can reveal whether or not a company should be concerned if a certain competitor drops its prices. Also, it can check whether a company’s demand is very sensitive to another company’s prices and use it to find a brand’s main competitor.
Income elasticity is a measure of how sensitive quantity demand is for my product to changes in the disposable income
Income elasticity gives us an idea about what category our product is. Please check the following table:
We can literally set a linear model here to present quantity demand on our product like the following:
Qx= α + price elasticity * own price+ Cross price elasticity * other’s price+ Income elasticity * Income + Trend variable * periods + ε
To find out the elasticity figure of a trend, we can simply use the Excel function: [EXCEL — DATA — data analysis — Regression] and get a descriptive table.
How to set a price against your competitor though?
1) If you have only one competitor in the market. The second player tends to find it most advantageous to price close to a single competitor in the market since elasticity is highest at the price of your competitor, and pricing close to existing price points tends to be the best strategy with one competitor in the market.
2) When there are only two competitors in the market, companies need to know which one they are competing against and price accordingly. With multiple competitors, companies don’t have to measure elasticity very carefully. They’ll need to price in the range where there is a plateau of elasticity. Companies can find their best prices in the range of prices between competitors.
3) Use demand function and differential method to optimize the price.
𝜋 = (P — MC)Q
𝜋 = price
MC = marginal cost
Q = quantity sold
In conclusion, after performing a price optimization, how should a company finally set its price?
1) Use the price found in the price optimization calculation.
2) Consider other real-world events, such as competitor pricing strategies.
3) Use other knowledge and judgment. Managers should also use their own common sense and knowledge when pricing.
4) Consider elasticities.