Price Sensitivity

Meaning and definition of Price Sensitivity

Price sensitivity can be defined as the degree to which consumers’ behaviors are affected by the price of the product or service. Price sensitivity is also known as price elasticity of demand and this means the extent to which sale of a particular product or service is affected. Another way of explaining price sensitivity is, “the consumer demand for a product is changed by the cost of the product. It basically helps the manufacturers study the consumer behavior and assists them in making good decisions about the products.The level of price sensitivity varies depending on various products and consumers. Price sensitivity, in economics, is generally quantified through the price elasticity of demand. 

As explained by Investopedia, homogenous good which are widely available are more prone to show evidence of price sensitivity. For instance, very often the consumers are not agreeable to pay even a few cents per gallon for gasoline, especially if a lower priced station is located nearby. Besides, some consumers are more price sensitive as compared to others. Consumers having fixed income or who are more frugal have a tendency to pinch pennies and look around for lesser prices. In the meantime, some consumers with a higher income might feel that searching for better deals many a times might not be worth their time thus being less price sensitive.

Explaining the concept of price sensitivity

In the past, many trade companies relied on two most common pricing strategies:

• “Cost plus” pricing which requires companies to make regular adjustments as their costs increase. Some cost charges like rent hike or collective bargaining agreement can, however, impact market participants in different ways thus forcing some companies to heave their prices more than the competitors.
• “Competitive pricing” is the second common pricing strategy. This strategy involves setting prices on the basis of price set by the competitors. This approach can, however, be problematic if the pricing does not reflect imperative differences in what is being proffered. Moreover, this approach presumes the competition creates the most effective price for a product or service.

Both of the aforesaid pricing approaches, however, share common failings. The most important one is the lack of critical information on what is willingly being paid by the consumers. Secondly, these pricing strategies depend largely on subjective judgment of the management instead of depending on data-driven empirical evidence determining the impact of distinctive pricing levels on demand.

Wrapping up, analyzing price sensitivity is highly useful in attempts to determine the impact created by the actual outcome of a specific variable if it is different from what ghas been assumed previously.  

Price sensitivity can be measured by dividing the percentage in the quantity purchased of the product or service with the percentage change in the price.

Formula

The standardized formula for measuring price sensitivity is:

Price Sensitivity = (Change in Quantity Purchased / Change in Price)*%

Example:

In order to observe the price sensitivity, let us consider that, when Nestle apple nectar prices increase by 60%, the juice purchases fall with the figure of 25%. Using the mentioned formula we can easily calculate the price sensitivity for nestle apple nectar:

Price Sensitivity = -25% / 60% = -0.42

Therefore, we can conclude that for every of the percentage with which the Nestle apple nectar price increases; it affects the purchase by almost more than half percentage. Likewise, all the products can be studied by taking into account the changes in price and increase or decrease in the demand.

Those products are said to be price sensitive in which the change in price is not much but the demand is affected on the large scale. This is the case usually with the convenience products or the products which have a huge range of alternatives. Those products which are not much reactive to change in price are called price inelastic. Such products are usually daily used products and are a necessity of life and consumers do not have any other option other than purchasing them.