How to work out price elasticity of demand

Strategically pricing your products or services lets you make the most of each sale and maximise profits. But what happens when the demand changes? 

If you know how to work out the price elasticity of demand, you can successfully adapt to a shifting market. This concept measures how flexible demand is based on price to better predict sales. 

If the term is new to you, it may seem confusing. But don’t worry; we can explain it.

This guide covers the price elasticity of demand, including:

• What is price elasticity of demand?
• How to work out price elasticity of demand 
• How to implement price elasticity of demand 

Price elasticity of demand (PED) compares the price of goods or services with the changing popularity or sales numbers. This calculation determines the flexibility of demand when pricing varies. 

The results show valuable information about a product or service, which can scale between elastic and inelastic. Let’s look at the difference:

• Elastic – variations in pricing impact the demand for products or services. If the price goes up or down, so does the popularity. 
• Inelastic – price fluctuations don’t affect the demand for a product or service. People will still buy something if the price increases or decreases.    

If the price elasticity is less than one, it’s inelastic. But if it’s over one, it’s elastic. 

A variety of factors can affect the elasticity of demand for products and services, including:

• Necessity – Do customers need these products or services, or are they desirable?
• Loyalty – how loyal are customers to your particular products or services or the general market?
• Availability – how many other product or service options are there out there? How rare is the offering?
• Budget – how much money does the typical customer have to spend?

When you run a small business, every penny counts. It’s essential to optimise sales and profitability to keep your operations alive. 

Understanding the elasticity of demand in the prices of your goods and services lets you alter your pricing to benefit your business. 

Overall, this knowledge will strengthen your sales and pricing strategy. You can set prices that are more competitive and convincing for potential customers. On top of that, you’ll understand how people may react to price shifts. 

It’s crucial to know if your prices are elastic because you may lose sales when you increase costs. So, though higher prices may increase profit margin, it may not lead to more significant revenue.  

But say you determine that your prices are highly inelastic. In this case, you could try increasing your rates to earn more from the sustained interest. 

Wondering how to work out the price elasticity of demand? We’ll cover the key components of understanding how it affects your business. 

The first step to figuring out the elasticity of demand is examining the products or services you sell. If you understand your customer demand and the overall market, you can more easily predict how people react to a price change. 

To learn more about general demand, consider doing some market research. But also calculate your business’s quantity of demand, or the number of products or services customers will buy at a given price. 

To calculate price elasticity of demand, you’ll need the percentage of change in demand and the percentage of change in price for your business. 

Here’s the equation:

Price elasticity of demand = % of the change in demand % of the change in price 

But how might you get those percentages? 

• % of the change in demand – (current quantity of demand – initial quantity of demand) (current quantity of demand + initial quantity of demand) 2
• % of the change in price –  (current price – initial price) (new price + initial price) 2

If these calculations seem confusing, you don’t need to worry about doing it accurately yourself. Instead, try using this handy price elasticity calculator.  

The loyalty of your customer base is another factor to consider in price elasticity of demand. Individual commitment might impact market elasticity. 

Say prices are generally elastic on a product, but your customers will pay you more because they’re loyal. In this case, your demand is less elastic than the general market. 

Once you understand your price elasticity of demand, you can implement this knowledge into your prices. 

Consider using elasticity or inelasticity to your advantage by setting prices that are responsive to customer demand. For example, you might reduce prices to increase demand or increase prices if you know demand will remain the same.

Knowing your elasticity can help you decide which pricing strategy might work best for your business.

For example, you might try introducing a dynamic pricing strategy. This model changes prices based on time, demand, or competition. Knowing the elasticity of your rates can help you decide how much to stretch them in time. 

See also: How to notify your customers of a price increase. 

Hopefully, this guide has helped you understand how to work out price elasticity of demand. If you calculate it for your business, you can create pricing that maximises your sales. 

But, to make the most of it, you’ll need to get your prices in front of the right eyes. To do this, check out our guide on how to build a sales strategy for your business. 

As you use price elasticity of demand to set competitive pricing, you’ll need to keep your finances organised to track your success. 

Countingup is the business current account and accounting software in one app. It automates time-consuming bookkeeping admin for thousands of self-employed people across the UK. 

Save yourself hours of accounting admin so you can focus on growing your business. 

Start your three-month free trial today.