Price SensitivityHow Prices affect Consumer decisions

Written By:
Lisa Borga

Reviewed By:
FundsNet Staff

Price sensitivity refers to how the price of a product affects a consumer’s desire to purchase a product or service. In business, this concept is often used in making pricing decisions.

As an example, a seller might sell hot dogs from a hot dog cart in the park and do good business.

But, if the seller increases the price by $0.15, and many people start buying hot dogs from the stand across the park, this would indicate high price sensitivity. In this situation, the hot dog seller may want to reconsider the price increase.

Price sensitivity can vary considerably. The type of products or services you are selling,  as well as the type of customers your business, tends to have, and any other market factors will influence price sensitivity.

Price sensitivity, when used in economics, is expressed as the price elasticity of demand. Price elasticity of demand can be calculated using the following equation.

Price elasticity of demand = % change in quantity demanded / % change in price

It is important for business owners to consider the relationship that exists between price elasticity and price sensitivity when setting prices.

If a product or service has high elasticity, then an increase in price is likely to lower the demand for the product.

In contrast, if a product or service has low elasticity, an increase in price will have less of an effect on demand.

The Importance of Price Sensitivity

You should make sure you are aware of the price sensitivity of your various products.

This information is vital in making decisions concerning price increases or decreases as it can help you to determine their likely effect on profits.

It can also assist you in determining the best time to institute any price changes as it can allow you to consider the current view of consumers.

However, since the factors affecting price sensitivity change frequently, it’s important to be sure your information is current, so you will be able to make the best pricing decisions possible.

Your goal is likely to be to set the price of a product or service as high as possible without lowering demand for the product.

This is difficult to do, and you probably will not be able to set the ideal price all of the time.

But, if you conduct a price sensitivity analysis, you can get as close as possible to your ideal price.

Factors That Influence Price Sensitivity

There are many factors that can influence price sensitivity, and we will discuss some of them.

The Kind of Good or Service

Some products or services tend to have low price elasticity.

Essential items, such as milk, gasoline, and bread, along with other items people consider a necessary part of their everyday life, are not likely to be very price sensitive. Demand for essential goods is probably going to remain stable even if prices increase.

Although, in particularly difficult times, price sensitivity could increase somewhat as people search for bargains.

There are also products that generally have high price elasticity because they are not essential. Luxury items, tickers to concerts or sporting goods, and vacations are common examples of products or services with high price elasticity.

Other factors, including brand or quality, have more of an effect on the demand for these products.

Reference Price

When a marketplace is crowded, consumers will generally look around, trying to find a good deal while shopping.

These consumers will get an idea of the general price for the item that they are shopping for, which is known as a price reference.

If there are several businesses providing very similar items, the consumer might be more likely to purchase the good from a different business based on the item’s price.

Companies can influence the reference price through a technique known as price anchoring.

Price anchoring is a type of cognitive bias that can cause a price to seem high or low based on other prices offered for similar products or services.

This is common in services that have tiered pricing. A basic package may seem cheap compared to higher packages, even if it might otherwise have seemed expensive.

Product Differentiation

If a company has a patent for a product or a recipe so that no one else can have an identical product, consumers will be more likely to accept a price increase. This is particularly true of essential items such as certain healthcare products.

When only one company offers an essential product, you are likely to pay whatever the price is because you have no choice.

A product can also be differentiated through brand identification.

Consumers can strongly favor some brands.

Because of this, it can be difficult to compare different products and get a fair reference price.

As an example of this, people that strongly favor a certain cell phone brand will be much less likely to substitute it for a cheaper cell phone than they would be to substitute one brand of bread for another brand of bread.

Reluctance to Switch Suppliers

In some cases, price sensitivity can be due to concerns the consumer has concerning switching from one seller to another.

Consumers may be unfamiliar with a new seller and, thus, reluctant to change.

They may be concerned about how reliable the new seller is and what type of consumer support they will receive.

Sometimes this will cause consumers to remain with their current seller even if a product is more expensive.

Income Levels

Another determinant of price sensitivity is consumer income levels.

Consumers that have less available income are likely to be more price sensitive. This is particularly true for high-cost items.

This type of price sensitivity will vary a lot between people and can also be affected by factors such as the economy being in a recession.

A Consumer’s View of Price

Price sensitivity can vary considerably based on a consumer’s view of price.

Price may be very important for some people yet not very important for others.

Other consumers may be much more concerned about the brand or quality of a product and therefore be a lot less price sensitive. High price sensitivity can even be affected by a person’s values or past experiences.

Reducing Price Sensitivity

Price is just one of many factors that affect consumers’ purchasing decisions.

There are many other factors that influence purchasing decisions as well, and there are some things that can be done to help reduce price sensitivity, such as using other demand factors.

Businesses can improve their customer service, increase brand awareness, try to make their products more unique, or use marketing to try to decrease people’s concerns about switching to their products in order to try and reduce price sensitivity.

Although, it is important to remember that a business might want to increase price sensitivity if their product is the cheapest in the area.

In this case, a business may want to market its product as being the cheapest and question why anyone would want to pay more.

Measuring Price Sensitivity?

You can use the formula for price elasticity of demand to calculate price sensitivity. The equation is:

Price elasticity of demand = % change in quantity demanded / % change in price

However, the information obtained from this formula is based on the past and shows how the price sensitivity has changed over a period of time.

This information does not explain the reason for the change in price sensitivity or how to respond to the change.

In order to understand what drives price sensitivity, it is important to consider consumers’ attitudes toward value, price, and what makes customers want certain goods.

It is best to consider what consumers will pay for a product before trying to sell the product.

Van Westendorp’s Price Sensitivity Meter can be used to help sellers set a price for a product.

The technique is used to help determine consumer price preferences and can provide a reasonable price range for a product and an ideal price point which can help you in setting prices.

The Gabor Granger pricing technique is another useful tool to use when setting prices.

It can help you evaluate the elasticity and price sensitivity of goods that are in the market.

This tool can help you to better understand the correlation between prices and consumer demand.

Final Thoughts

Setting the best prices for your products is vital to making the maximum profit possible for your business.

Therefore, you should take the time to conduct a price sensitivity analysis by carefully considering the customers and competitors in your industry before setting your prices.