Price Elasticity of Demand

Feb 24, 2018

Ok, time to get our nerd hats on.

No, seriously — this lesson comes straight out of the college campus lecture from Macroeconomics.

Today’s blog post revolves around a concept known as Price Elasticity of Demand. Say that five times fast (but do it in front of your friends so they think you’re crazy smart). All this fancy terminology means is “how much demand for a product changes when you only adjust price.” Of course, there are far more reaching implications than this simple sentence, but the common denominator here is “if I adjust only the price of my product, does the demand for the product change?”

The amount or degree to which your demand changes after a price change is the measure of elasticity. If you change your price and the demand responds in a major way, your product is considered “elastic.” If, however, you change your price and the demand responds more slowly, your product is considered “inelastic.”

“Uh, professor? Why should I care about this stuff? I sell widgets on Amazon!”

Great question. Most people don’t even know about this principle, let alone use it as a tool when they sell on Amazon. Let’s dig into how this principle can help you in your quest for online domination.

Let’s start with a couple of examples.

First, let’s take a look at elastic goods or, in other words, goods where the demand is very sensitive to changes in price. Think about things in your life that you would decide not to buy if the price (only the price, remember) changed substantially from one weekend to the next during your shopping. Let’s say you went out one weekend and took a look at a couch, liked it, but didn’t have a truck handy so you told them you’d be back next weekend to grab it. When you arrived the next weekend, the price had gone up 20%. Same couch, nothing changed but the price. Are you still going to buy it? Most likely you’ll have a large response to this price change and have to re-think your decision. The same goes for a car, a boat, or even carpet cleaning services. Why? Because for these items, you have plenty of alternatives to choose from — you can substitute your choice to fit your budget. This is an even more painful price change if you’re purchasing an item that represents a large portion of your income. The more options you have, the more money it costs, and the less “necessary” the item is…the more this price will affect your buying decision.

Now, switch gears with me for a second. Let’s discuss inelastic items for a minute. You’re driving down the highway 50 miles from home, and the low fuel warning light turns on. You noticed that yesterday the price of fuel was 20% cheaper than today. What are you going to do? You’re going to stop and fill your car up with fuel. Why? Because the fuel is necessary for you to drive your car and there aren’t other substitutions for unleaded fuel in your vehicle. Gasoline is considered highly inelastic because a large swing in price will not deter you from filling up your car. The cost of filling up your car doesn’t represent a huge portion of your income so you will adjust your budget to fit your choice to fill up your tank. See the inverse decision from elastic goods?

Well — awesome. So, what does this have to do with selling on Amazon again?

Product selection, pricing adjustments, competition analysis, advertising, and listing creation are a great place to start.

When you’re deciding what to sell on Amazon, remember that people respond differently to price changes in elastic vs. inelastic goods. Should I sell bluetooth headphones? Or hand made soap? Should I sell folding stadium chairs? Or organic toilet paper? Each of these items has a drastically different response to significant price changes. This is important to remember if you have margin to discount your items, budget to run advertisements, plans to run pulsed deals, or want to find something that is less seasonal and more of a flat demand curve.

A few key factors that can help you determine a good’s Price Elasticity of Demand:

  • Product selection/product availability
  • Search term breadth of scope
  • Item cost
  • Necessity of item to consumer

Product selection – This can be summed up in one word: substitution. If there are a million other options of the widget you’re looking to sell, most likely that product will be highly elastic (a significant price change will greatly influence a customer’s purchasing decision). Why? Because if you, as a consumer, have 500 other options that seem extremely similar in functionality, design, quality and customer reception (reviews) — you’re going to do your shopping to find the cheapest option that has everything you want. Consumers are very sensitive to price changes when a ton of other options exist and it’s very easy to substitute your product for another. These products typically get in pricing wars, and are a big reason why “auto repricing” companies are in business. Products that have very little substitution availability will respond far less to substantial changes in price, as people literally have fewer options to “switch” to.

Search term breadth of scope – This concept applies to the difference between broad and specific keywords. Think of what will pop up on Amazon when you search for the term “jars.” Now think of “glass jars.” What about “glass spice jars”, or “glass spice jars for cinnamon”, or “glass spice jars for cinnamon with changeable inserts” or lastly, “glass spice jars for cinnamon with changeable inserts and removable lid.”  This concept can be a bit tricky — but which do you think is the most elastic? If you guessed “glass spice jars for cinnamon with changeable inserts” you would be spot on. Why? This seems counter-intuitive? The more specific a keyword is, the more elastic it is because exact substitutes are more easily found and available to “switch” to. The more broad a term is, the fewer the exact substitution possibilities. Think “food” vs. “Burger King hamburger.” What’s the substitution for food?

Item Cost – This one makes logical sense right out of the gate. If something is relatively cheap or consumes a tiny portion of our income, the less sensitive we are to its price. Conversely, if something takes a large bite out of our income we are far more sensitive to the item and large changes in price. Think of buying a boat vs buying toothpicks. Boats are highly elastic items, whereas a toothpick is relatively inelastic (we need it, the cost is low, and price fluctuations won’t affect our choices much…if at all).

Necessity of Item to Consumer – This concept can probably go without explanation. Ask a woman dying of thirst in the middle of the desert how much she’ll pay for a glass of water…she’ll give you whatever she has as the alternative is death. Electricity, water, clothing and even items like tobacco have relatively low elasticity as they are perceived as highly necessary to the consumer.

Now — take all of this knowledge and apply it to your current situation. Are you looking for an item to sell on Amazon? Pay particular attention to your competitive landscape. How many other widgets are there that are easy to switch to from yours? Are they necessary to the customer or merely a nicety? Are they expensive and represent a larger purchase, or small and not taking a bite out of someone’s income? How exact does the consumer have to be in order to find your item? When you combine the answers to all of these questions, you can analyze categories, items, and even your potential competitors in a whole new light. Take your product selection process to the next level and figure out how to get exactly what you want. Do you want a product that consumers will respond greatly to a large sale/promotion/discount? Or do you want an item that customers will maintain standard purchasing habits regardless of large swings in price?

If you’re currently selling an item on Amazon, this information can still help you in your promotion and advertising efforts. Is your item elastic or inelastic? If you’re on the elastic spectrum, are there profitable ways to get a large response out of consumers by changing your price or highlighting the necessity, cost, or specificity of your particular widget? How can you command the Price Elasticity of Demand to drive your sales higher?

Whether you’re new to Amazon or a seasoned expert — take a page out of the old college Macroeconomics textbook and apply the Price Elasticity of Demand to your current strategy, you might just be pleasantly surprised as you push those glasses back up on your nose….

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