Marketers and finance departments spend countless hours and dollars scrutinising competitors and consumer demands when determining the appropriate price for a product or service. While some economic factors, which affect price, can be anticipated, many of these economic factors are a product of the overall economy or the economic structure of the market the firm is operating in.
The primary factor effecting the price of an item is based on the law of demand. There is an inverse, or negative, relationship because price and demand, or the amount of an item consumers are willing to purchase. Consumers generally want to buy more of a product when the price is low and less when it is high.
The elasticity of demand refers to how sensitive consumers are to the price of a specific product. Products with high elasticity are those in which a slight increase in price will lead to consumers demanding less, or less revenue generated for the product. A product may be highly elastic if there are various substitutes for it, if it is a luxury good or if it is a product or service that consumes a large portion of the consumers' income. Very inelastic goods tend to be items that are seen as necessities. A change in price is likely to have no, or very little, change in the quantity demanded. An example of this would be gasoline: Since it is required to fuel your car in the short term, there is likely to be little change of quantity demanded based on a price fluctuation.
The type of market that the product or service is being sold in affects pricing decisions. For example, in a perfect competition there are many buyers and sellers of a standardised product, so firms in this market are described as "price takers," which means they cannot individually influence control over the price. If they desire to sell the product, they must adhere to the market price. At the opposite end of the spectrum is an oligopolistic market, where there are a small number of firms dominating one market. Since one firm is a substitute for another in this type of market, consumers are very sensitive to price and will quickly switch to another firm for the best price.
During a recession prices tend to be lower as consumers are spending less and demanding lower prices. After merchandise has been languishing on the aisles or in the store for so long that it becomes a liability to the firm, the store slashes prices in order to move older inventory. This is particularly true in the start of a recession when manufacturers and retailers are projecting their sales on an assumption they will be operating in a stable market. As evidence of the recession mounts, prices must be lowered in order to move this merchandise and reduce the loss.