Accounting for inflation in price elasticity modelling

  • 12 May 2022
  • 3 replies

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I’m wondering if anyone has done any research into/has had any success in accounting for inflation in their price elasticity modelling? Given the sharp rise in fuel, energy and food prices over the past few months, an item that was once quite elastic may now be very elastic, especially when considering luxury items.

I.e. a small price increase of a luxury product in today’s financial climate may result in a greater drop in demand than it would have previously.

If you build an elasticity model on many year’s worth of historical sales data, should you weight recent data more favourably to account for this sort of behaviour? Is there an alternative way to account for inflation?

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Hey @RebekahYates ! Can you explain what the price elasticity model will be used for?

For example, are you after predictions of the elasticities themselves or are they part of a larger model?

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The elasticity model is used to estimate the elasticities themselves. That said, those predicted elasticities do make up a larger solution too. I have a separate demand forecast which predicts the demand for a product at its current price. I then combine this with the elasticity values to predict the demand at a range of different prices, with the aim of finding the optimal price subject to certain KPIs. 
It might make more sense to account for something like inflation in the forecast instead… I’m not sure!

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Thanks for clarifying!

I think this is a very interesting problem and one I don’t personally have any practical experience with.  Thinking about this purely from an abstract “modelling” perspective, the important questions to me (at this stage) seem to be:

  • Do we expect this thing (the price elasticity) to vary with inflation in ways which are relevant to the wider problem? Would it be possible to study this with data you already have somehow?
  • Can we actually model the relationship between inflation and price elasticity? Do we have enough data to do this in a way that improves the model over assuming the elasticity doesn’t change with inflation?

I think the best thing to do here might be to get the advice of some folks with pricing experience.

At any rate it would be great if we try to keep this thread updated for the benefit of anyone who encounters a similar problem in the future.