Price elasticity: how to use it to optimize your price
Learn what price elasticity means, how to calculate and test it, and how to find your optimal price point with SurveyMonkey LaunchPad.
What is price elasticity, and do you need to consider it when pricing your products or services? Keep reading for in-depth, useful information on determining the optimal price point for your products.
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What is price elasticity?
The basic definition of price elasticity of demand is the measurement of the change in demand for a product in relation to a change in its price. Price elasticity of supply is the measurement of the responsiveness of the supply of a product after a change in its market price.
The price elasticity of demand is calculated by this mathematical calculation:
Price elasticity of demand = percentage change in quantity demanded / percentage change in price
The price elasticity of supply is calculated by this mathematical calculation:
Price elasticity of supply = percentage change in quantity supplied / percentage change in price
Together, these two measurements show how much the supply or demand for a product changes based on a change in its price. This is used to determine what products are produced at what prices. This guide focuses mainly on the price elasticity of demand.
Price elasticity of demand is used as a basis for:
- Identifying products that are important to customers
- Identifying products that customers generally compare prices for
- Calculating profit scenarios for a variety of price points
- Driving your pricing strategies
- Analyzing the effects of policies such as taxation and minimum wage on consumer behaviors
- Measure effects of change in income on consumer behavior
- Determining if a product is worth selling
The price elasticity of demand can be categorized into types based on the calculation provided above.
- Perfectly elastic: If the equation yields a result of infinity (or unlimited quantity), it is perfectly elastic, and a small rise in price results in a demand decline to zero, or a small fall in price increases demand to infinity. Perfectly elastic demand is theoretical. It does not apply to real situations.
- Relatively elastic: A result greater than one indicates that a product is relatively elastic and changes in price trigger substantial changes in demand—the proportionate change in demand is greater than the proportionate change in price.
- Unitary elastic: If the result is equal to one, the product is unitary elastic. A change in price equals an equivalent percent change in demand.
- Relatively inelastic: A result of less than one equals inelastic. Percentage changes in price yield insignificant percentage changes in demand.
- Perfectly inelastic: If the equation equals zero, the product is perfectly inelastic, and changes in price cause no change in demand. This is a theoretical concept and cannot be applied in a practical context.
Examples of elastic goods
Elastic goods tend to be comfort goods, commodities, and luxuries: items not essential to life.
- Soft drinks. They taste great, but they are not necessary items. A significant price increase pushes buyers toward cheaper brands; a decrease keeps existing customers and can attract new ones.
- Cereal. With so many competing brands on the shelf, a cereal priced above its competitors quickly loses demand.
- Clothing. Thousands of alternative products and brands mean demand is highly sensitive to price.
- Cars. Buyers often have a preferred make and model in mind, but plenty of alternatives exist. Price increases push buyers toward other models; decreases attract buyers to the less expensive ones.
- Gym memberships. A gym membership feels like a necessity to some, but it is a luxury with many substitutes, including exercising at home, which makes it elastic.
Examples of inelastic goods
Inelastic goods tend to be necessities and commodities, where supply and demand are less sensitive to price changes.
- Life-saving medication. When medication like insulin is required to live, buyers purchase it regardless of cost.
- Gas. Most vehicles still run on gasoline, so people buy it regardless of price changes to get to work and other necessary destinations.
- Electricity. Integral to daily life, with most people unwilling or unable to meaningfully cut usage or switch to alternatives when prices rise.
- Cigarettes. Addiction keeps demand steady even through price increases.
- Post-secondary education. Certain careers require degrees or certifications that can only come from a college or university, so tuition increases have little effect on demand.
Factors that affect elasticity
Three main factors affect the price elasticity of a product: the availability of substitutes, the urgency of the need for the product, and the duration of the price change.
Availability of substitutes
When it is easy to substitute one product for another, a price increase on one pushes demand toward the other. If cola Brand A raises its price, many buyers will simply switch to Brand B, and demand for A will fall.
Urgency
The more urgent a need, the more a buyer is willing to pay regardless of price. With discretionary purchases, price increases cause demand to fall more sharply. Someone shopping for a dishwasher that still works, rather than one that just broke, can afford to wait for a better price.
Length of a price change
Short-term price changes, such as a weekend sale, produce a temporary spike in demand that fades once the promotion ends. Sellers need to account for how long a price change lasts when interpreting the demand shift it produces, since a holiday price increase behaves differently from a permanent one.
Price elasticity testing: how to measure it with survey data
Calculating price elasticity from historical sales data works only if you already have enough sales history at more than one price point. Price elasticity testing solves this by measuring price sensitivity directly, through a survey, before you commit to a price.
Ways to calculate or test price elasticity compared
| Method | Data needed | Best for |
| Formula-based calculation | Historical sales data at two or more price points | Products with an established sales history and past price changes to compare |
| Van Westendorp Price Sensitivity Meter | A four-question survey fielded to your target market | New products, or any product without enough price history to calculate elasticity directly |
| Gabor-Granger method | A survey testing purchase intent at several specific price points | Estimating a demand curve and revenue at specific candidate prices |
How to optimize your price using pricing elasticity: step by step
- Decide whether you can calculate elasticity directly. If you have reliable sales data from more than one price point, you can calculate elasticity with the formula above. If not, move to price elasticity testing instead.
- Calculate your marginal cost. Marginal cost is the change in total production cost from making one additional unit: marginal cost = change in cost / change in quantity.
- Apply the optimal price formula. Optimal price = marginal cost multiplied by (price elasticity divided by price elasticity plus 1). For example, a marginal cost of $6.00 and a price elasticity of -4.0 gives an optimal price of $6.00 times (-4.0 / -3.0), or $8.00.
- If you lack sales history, run a Van Westendorp study instead. Price Optimization from SurveyMonkey LaunchPad builds this survey for you and plots the results automatically. In an illustrative example on that product page, an optimal price point of ten dollars sits inside an acceptable range of eight to twelve dollars, the kind of output the method produces once responses come in.
- Re-test after any major shift. Elasticity is not fixed. New substitutes, an economic downturn, or a change in urgency can all shift how customers respond to your price, so treat this as a recurring check, not a one-time calculation.
Find the optimal price using Van Westendorp analysis
The Van Westendorp Price Sensitivity model, developed by Dutch economist Peter Van Westendorp, is used to determine optimal prices based on price sensitivity. The model indirectly measures the target market's willingness to pay, providing you with a range of prices. It is one of the most effective and popular pricing methods in the market research industry.
The model uses a survey with four core questions, typically variations of these:
- What price would be so low that you would start to question this product’s quality?
- At what price would you consider this product a bargain?
- At what price does this product begin to seem expensive?
- At what price is this product too expensive?
These questions provide a comprehensive view of the price range customers are willing to pay for your product. Check out the Price Testing Template, which can be customized with the right questions to fit your pricing survey needs.
Frequently asked questions about price elasticity
What does price elasticity mean?
Price elasticity measures how much the quantity demanded, or supplied, of a product changes in response to a change in its price, expressed as the ratio of the percentage change in quantity to the percentage change in price.
Is a price elasticity of 0.5 elastic or inelastic?
A result of 0.5 is inelastic, since it is less than one. A price change on that product produces a smaller proportional change in demand.
What is price elastic versus price inelastic?
An elastic product's demand changes significantly when its price changes, typically because substitutes are easy to find. An inelastic product's demand barely changes with price, typically because it is a necessity with few substitutes.
How do you test price elasticity without historical sales data?
Use a survey-based method such as the Van Westendorp Price Sensitivity Meter or the Gabor-Granger method, both of which estimate price sensitivity directly from your target market instead of requiring past sales data at multiple price points.
Determine the optimal price for your product
Price elasticity measures how much the supply or demand for a product changes based on a change in its price. It is influenced by the availability of substitutes, urgency, and the length of a price change. If you can calculate or test your product's elasticity, you can use that data to determine its optimal price.
Price Optimization from SurveyMonkey LaunchPad builds a Van Westendorp study for you and turns responses into an acceptable price range, floor, and ceiling automatically, the fastest path to an optimal price when you do not already have the sales history to calculate elasticity directly.
If you'd rather hand the legwork to someone else, SurveyMonkey Market Research Services can design, field, and analyze a custom study for you, from questionnaire design through the final report.
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