3. 3
•What drives purchase preference for my brand?
•How should I position my brand to attain a higher rate of brand loyalty?
•What are the drivers of quality perception?
•What is the price elasticity of my brands? What should be the pricing
strategy for my brand? Elasticity is a very important input into the retail
analytics
•How is the changing lifestyle affecting buying behavior of my consumers?
•How can I leverage consumer perception about my brand to cross-sell
different products?
•What competitive threats am I facing? What are the new opportunities in
market I could leverage?
It is in an organization’s interest to view consumers as longer-term valuable
assets, and not just as prospects for the next sale.
Often repeated questions facing the companies are
5. 5
What is Price elasticity
Price elasticity of demand can be defined as the responsiveness of
demand to a change in price. It is a measure which tries to capture
the consumer’s sensitivity to price changes.
P
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Q
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e d
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6. 6
Calculation of price elasticity-An example
Illustration: (a) A 10% decrease in the price of an ice cream cone
causes the amount of ice cream demanded to increase by 20%.
Price elasticity here is 2. (elastic)
(b) If the price elasticity is 0.2, this means a 10% decrease in price
would cause the demand to increase by 2%.(inelastic)
7. 7
1. Inelastic : Goods for which price elasticity is less than 1 is
called inelastic. For instance (a) demand for eggs for breakfast
(b) demand for salt. It is inelastic because it has very few
substitutes
2. Elastic: Goods for which price elasticity of demand is more
than 1 is called elastic demand. For instance demand for
foreign travel for a holiday. It has many substitutes.
3. Unitary elastic: Goods for which price elasticity of demand is
almost equal to 1.
Types of elasticity of demand
8. 8
Example: Pricing admission to the aquarium
Suppose you are a manager to a large public aquarium.
Aquarium manager says the aquarium is running
Short of funds. He suggests you consider changing price
Of admission to increase total revenue.
Q. What do you do. Do you raise your price of admission
To increase total revenue or do you lower it.
A: It depends on the price elasticity of demand.
To estimate PED one could use historical data. In order to isolate
price effects-other factors like weather, population, size and variety
of fish etc all need to be considered.
10. 10
Predicting the size of the price increase- Iraqi invasion
of Kuwait.
Economists actually used the numerical value of the elasticity to
predict the size of the oil price rise caused by the Iraqi
invasion of Kuwait in 1990. The steps were as follows:
1. First they determined the elasticity of demand for oil was
0.1. This was calculated looking at historical data on oil
prices and quantities.
2. They calculated –after the consulting with oil producers –
that the invasion of kuwait would reduce the world oil
supply by 7%. They assumed that this 7% would also be the
fall in quantity demanded since other sources of oil could not
increase in the short time.
11. 11
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This type of calculation –showing a huge increase in
price of oil caused by a 7% reduction in oil supply –
was a factor in the decision by the US and its allies
to send troops to halt the Iraqi invasion of Saudi
Arabia and eventually force Iraq out of Kuwait.
12. 12
Use of price elasticity to producers
• Firms can use Price elasticity to use to predict
(a)The effect of a change in price on the total revenue and
expenditure on product.
(b) The likely price volatility in a market following unexpected
changes in supply
(c)effect of change in the government indirect tax on price and
quantity demanded. Whether the business will be able to pass on
some or all the tax to the consumer.
(d) info on price elasticity can be used for price discrimination or
yield management,
13. 13
Segments Price Elasticity Consumer behaviour
Daily consumables Very Low Will continue to buy in same
proportions
FMCG high Will continue to buy in lesser
or higher proportions
Automobiles Moderately High Demand will move to lower
end or high end of the
segment
Housing High Consumer will have a wait
and watch attitude
Vacations Very High Demand will be significantly
impacted
Price elasticity and Consumer behaviour-
Across key segments
15. 15
Total revenue and price elasticity of demand
Total revenue = price*quantity
How does the total revenue move along the demand
curve. The answer depends on the price elasticity.
1. When the demand is inelastic ( a price elasticity
less than 1 ) price and total revenue move in the
same direction
2. When the demand is elastic , price and total
revenue move in the opposite directions.
16. 16
Price Qty TR elas e
2 90 180 -0.11 Inel
4 80 320 -0.25 ine;l
6 70 420 -0.43 Inel
8 60 480 -0.67 Inel
10 50 500 -1.00 Ue
12 40 480 -1.50 elas
14 30 420 -2.33 elas
16 20 320 -4.00 elas
Relationship between total revenue and elasticity
E<1, a rise in price,
leads to rise in TR
E=1, TR is max
E>1, an increase in
price leads to a fall in
revenue and vice
versa
18. 18
Elasticity and price discrimination-
Example 1:airline industry
Price discrimination is different groups of people are
charged different prices for the same item.
This type of price discrimination is very prevalent in
the airline industry. Vacationers are more price
sensitive than business travellers. Vacationers are more
flexible as far as travelling is concerned. The price
elasticity of a business traveller is low. The difference
between the price elasticities between the two groups
is the reason for price discrimination.
19. 19
Pricing Strategies Market
penetration/market skimming
The practice of ‘price skimming’ involves charging a relatively high
price for a short time where a new, innovative, or much-improved
product is launched onto a market. This could be particular useful
for luxury goods , prestige goods, “designer label” clothing
The objective with skimming is to “skim” off customers who are
willing to pay more to have the product sooner; prices are lowered
later when demand from the “early adopters” falls.
The success of a price-skimming strategy is largely dependent on
the inelasticity of demand for the product either by the market as
a whole, or by certain market segments.
The main objective of employing a price-skimming strategy is,
therefore, to benefit from high short-term profits (due to the
newness of the product) and from effective market segmentation.
20. 20
Market penetration
Penetration pricing involves the setting of lower, rather than higher
prices in order to achieve a large, if not dominant market share.
This will only be possible where demand for the product is
believed to be highly elastic, i.e. demand is price-sensitive and
either new buyers will be attracted, or existing buyers will buy
more of the product as a result of a low price .
21. 21
Housing demand -elasticity implications
• Demand for housing is a function of interest rate
one pays for the funds, location of the house, etc.
• In various empirical studies, it is seen demand for
housing is very responsive to interest rates.
• World over various measures like cutting interest
rates have been taken to boost demand.
• In India also measures to cut interest rates on
loans have been resorted.
23. 23
Empirical methods used to estimate elasticity of demand
1. Regression methods-using a log linear model
2. Simultaneous model
3. Cointegration and error correction model –used to
estimate the long run and the short run elasticities
24. 24
Using packages like SAS or even excel one could calculate this
For instance if one has to calculate the price elasticity of
demand for beef in a simple log-linear demand model. The
data consist of quarterly retail prices and per capita
consumption for beef. The data period covers the first
quarter of 1977 through the third quarter of 1999. The log-
linear demand model is of the following form:
lnQ = a + b·lnP
where Q and P are defined as before, a and b are
parameters to be estimated.
b=dlnq/dlogp
25. 25
Determinants of the size of price elasticity of demand
Degree of substitutability
Big ticket versus small ticket items
Temporary versus permanent price changes
Differences in preferences
Long run versus short run elasticity
26. 26
Degree of substitutability: If the people are able to find
substitutes for the product then the price elasticity
would be very high. Travelling abroad for a holiday.
The degree of substitutability depends on whether
the good is a necessity or a luxury. Or instance there
is no good substitute for a refrigerator per se (this is a
necessity in order to preserve food) but a fancy
refrigerator with blends with the rest of the kitchen is
a luxury. (in this case refrigerator would likely to
have a demand elasticity of less than 1 while within
the refrigerator segment the brands could have an
elasticity of more than 1.
27. 27
Big ticket versus small ticket items: If the item
represents a huge fraction of the income then the price
elasticity would be high. For example foreign travel
for a holiday. If the good represents a small fraction of
the income the elasticity is likely to be low. For
instance demand for eggs.
28. 28
Temporary versus permanent changes: If the price
change is expected to be temporary the price
elasticity is likely to be high. For instance demand
for a sewing machine on a sale day. People would
shift their demand to buying the sewing machine to
the sale day. However if the price cut is permanent
then the price elasticity is likely to be smaller.
29. 29
Differences in preferences: various groups of consumers
would have different levels of elasticity. Young
cigarette smokers, who are not possibly addicted to
smoking may be more sensitive to price changes to
cigarettes than those who are chain smokers.
30. 30
Long run versus short run elasticity: Frequently Price
elasticity is low immediately after the price change has
taken place . The short run is the period of time before
people have made adjustments or changed their habits.
The long run is long enough for people to make
adjustments to their lifestyles. For instance, when the
price of gas increases, in the short run people can reduce
their demand for gas by driving less, using bus service
etc. This could be cumbersome and at time not
practicable. In the long run however people would look
out for more fuel efficient cars so that they optimise the
use of gas. In the long run the quantity demanded is
more responsive than in the short run.
32. 32
Income elasticity of demand is the percentage change in the
quantity demanded to a percentage change in income. For instance
in the income elasticity of demand for healthcare was calculated as
1.5 and if the incomes were to rise by 10%, then demand would
increase by 15%.
For most of the goods when the incomes rise the demand increases
For instance demand for movie tickets. These are called normal
goods.
There are however a separate class of goods called Giffen goods
whose demand falls with an increase in income. For instance
demand for bus rides.
34. 34
Cross price elasticity is defined as percentage change
in quantity demanded divided by percentage change in
price of another good.
Cross price elasticity would be positive if the goods
are substitutes. For example hotdogs and hamburgers.
If price of hotdogs increases, people would grill
hamburgers instead.
Cross price elasticity would be negative if the goods
are complements. Example : computer hardware and
software. Increase in price of computers would reduce
the quantity demanded of software.
35. 35
Price Elasticity of supply
The price elasticity of supply is a number that tells
us how sensitive the quantity supplied is to price. It
is defined as a percentage change in quantity
supplied to the percentage change in price.
The price elasticity of supply is useful in
determining how much prices will change when
there is a change in demand.
