What is the income effect?
12/20/2022 - Pricing strategy
The income effect is the phenomenon by which changes in consumers’ incomes result in variations in the level of demand for e-commerce businesses. According to the income effect, the demand for a product or service can increase or decrease depending on users’ purchasing power. Although it might seem obvious that the more money people have, the more they spend, it doesn’t affect all brands and retailers to the same extent. This is why it is crucial to understand how the income effect could affect your business. It is also vital to review your pricing strategy to ensure that you are prepared for any changes in the market. We explain the key factors to consider.
How the income effect impacts e-commerce businesses
The main thing to consider is that the income effect can be positive or negative depending on the availability of substitute goods on the market and the elasticity of demand.
Positive income effect
This occurs when an increase in customers’ incomes results in increased demand. This positive effect occurs with ‘normal goods’, i.e., products that respond to expected behaviour. This group includes staple goods and luxury or high-quality items like branded clothing. However, you need to be aware that normal behaviour dictates a likely reduction in demand if prices increase.
Negative income effect
On the other hand, a negative income effect occurs when an increase in consumers’ available income results in reduced demand. This happens with inferior goods, items that may be substituted by more expensive products which users consider to be of better quality. Therefore, users choose to flex their higher purchasing power. An example of this would be white-label goods in a supermarket.
To be able to react to a possible negative income effect, you need to classify your products correctly and conduct an in-depth study of demand. It is also vital to know your competitors’ prices, strategies, and catalogues so that you can predict users’ behaviour.
Dynamic pricing to help you adapt to changes in the market
Once you have information on demand and your competitors, you can implement a dynamic pricing strategy. This will help you to react better to any change in the market. Changes may be due to economic improvements and increased users’ incomes, as occurs with the income effect. Alternatively, they may be due to external factors like shortages or inflation. With dynamic pricing, you can vary the price of every product to ensure that prices are always attractive and competitive.
One of the best ways to implement dynamic pricing in your e-commerce is by using an automated dynamic pricing tool. The most advanced software, like Reactev, allows you to set new prices by defining pricing rules, like the conversion rate or the profit margin. These prices can be tailored to each buyer persona and the time of year, guaranteeing the best possible profits for the e-commerce business.
Category: Pricing strategy
