Concept of demand

1. CONCEPT OF ELASTICITY
DEMAND
By- Aditya Krishna Gupta
BBA LB (Hons.), 1st Year
Enrollment no.- 02616503522

2. 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 THE
COMPANIES ARE FACING

3. Elasticity of demand: The degree of responsiveness
of demand for product to change in its price is called
the elasticity of demand.
The concepts of elasticity of demand generally used in
business decisions are:
1. Price elasticity of demand
2. Cross elasticity of demand
3. Income elasticity of demand
4. Advertisement elasticity of demand
5. Elasticity of price expectations

4. PRICE
ELASTICITY

5. WHAT IS PRICE
ELASTICITY
Price elasticity of demand can be defined as the responsiveness
or sensitiveness of demand for a commodity to a change in its
price. It is a measure which tries to capture the consumer's
sensitivity to price changes.
Elasticity of price = Percentage change in quantity demanded
Percentage change in price

6. 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)
CALCULATION OF PRICE
ELASTICITY

7. TYPE OF DEMAND ELASTICITY
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.
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.
Unitary elastic: Goods for which price elasticity of demand is almost equal to 1.

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.

9. Illustrative use of price e asticity

10. Predicting the size of the price increase- Iraqi invasion of Kuwait. Economists actually used
the numerical value of the elasticity to 1. 2. predict the size of the oil price rise caused by the
Iraqi invasion of Kuwait in 1990. The steps were as follows: First they determined the
elasticity of demand for oil was 0.1. This was calculated looking at historical data on oil prices
and quantities. 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. • 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. • 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. • Price elasticity and Consumer behaviour- Across key segments Segments
Daily consumables FMCG Automobiles Housing Vacations Price Elasticity
Very Low high Moderately High High very High Consumer behaviour Will
continue to buy in same proportions Will continue to buy in lesser or higher
proportions Demand will move to lower end or high end of the segment
Consumer will have a wait and watch attitude Demand will be significantly
impacted

14. • Elasticity and total revenue

15. • Total revenue and price elasticity of demand Total revenue = price*quantity
How does the total revenue move along the demand 1. 2. curve. The answer
depends on the price elasticity. When the demand is inelastic ( a price
elasticity less than 1 ) price and total revenue move in the same direction
When the demand is elastic , price and total revenue move in the opposite
directions.

17. • Uses of _price elastic'ty

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. • 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. • 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. • Measurement of price el sticity

22. • Empirical methods used to estimate elasticity of demand 1. 2. 3. Regression
methods-using a log linear model Simultaneous model Cointegration and error
correction model —used to estimate the long run and the short run elasticities

23. • 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 + be Inp where Q and P are defined as before, a and b are
parameters to be estimated. b=dlnq/dlogp

24. • eterminants of the size of price elastic•ty 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

25. • 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.

26. • 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.

27. • 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.

28. • 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.

29. • 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.

30. • Income elasticity of de and

31. • 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.

32. • Cross elasticity of emand

33. • 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.

34. • What Is Advertising Elasticity of Demand (AED)?
• Advertising elasticity of demand (AED) measures a market's
sensitivity to increases or decreases in advertising saturation.
Advertising elasticity measures an advertising campaign's
effectiveness in generating new sales. It is calculated by
dividing the percentage change in the quantity demanded by
the percentage change in advertising expenditures. A positive
advertising elasticity indicates that an increase in advertising
leads to a rise in demand for the advertised good or services.

35. • Understanding Advertising Elasticity of Demand (AED)
• The impact that an increase in advertising expenditures has on sales
varies by industry. Companies frequently review their advertising-to-sales
ratio to measure the effectiveness of their advertising strategies. Quality
advertising will result in a shift in demand for a product or service.
Advertising elasticity of demand is valuable in that it quantifies the change
in demand (expressed as a percentage) by spending on advertising in a
given sector. Simply put, it shows how successful a 1% increase in
advertising spend is for raising sales in a specific sector when all other
factors are the same.
• For example, a commercial for a fairly inexpensive good, such as a
hamburger, may result in a quick bump in sales. On the other hand,
advertising for a luxury item—such as an expensive car or piece of
jewelry—may not see a payback for some time because the good is costly
and is less likely to be purchased on a whim.
you determine the advertising elasticity of demand for a product or service using the formula:
AED = % Change in Quantity Demanded ÷ % Change In Advertising Spending

36. Elasticity of price expectations
The concept of price expectations elasticity was devised and popularized by J.R Hicks in
1939. The price expectation elasticity refers to the expected change in future price as a
result of change in current prices of a product. The elasticity of price expectations is
defined and measured by the general formula given below: