Download HL MARKETING THEORY ELASTICITY

HL MARKETING THEORY
ELASTICITY
IB BUSINESS & MANAGEMENT –
A COURSE COMPANION: p214-218
ELASTICITY
Price Elasticity of Demand (PED)
• PED measures how sensitive the quantity
demanded is to changes in the price.
• You would expect the demand for most goods
to fall as the price increases, but PED
measures how much of a fall is likely.
• It is important to distinguish between elastic
and inelastic demand.
Elastic Demand
• A relatively small change in price, leads to a
disproportionally large change in demand.
• For example, the price of a bottle of wine is
increased by 10% and there is a 30% decline in
demand for the product.
• With calculations, an elastic good or service
will have a number greater than 1.
Inelastic Demand
• A relatively large change in price results in a
disproportionally small change in demand.
• For example, the price of gasoline in the
United States increases by 15%, but there is
only a 3% change in demand for gasoline.
• With calculations, an inelastic good or service,
will have a number less than 1.
What determines whether a good or
service is elastic or inelastic?
The number of substitutes
• When there are many substitutes, a product or service will
generally be characterized by elastic demand.
• When there are few or no substitutes, a product or service
will generally be characterized by inelastic demand.
Essential Goods/Service & Non Essential Goods/Services
• Goods & Services which are essential for all consumers will
generally be characterized by inelastic demand.
• Good & Services which are not essentials or luxury items
will generally by characterized by elastic demand.
Seasons / Time of the Year
• The season or time of the year can have a great impact on
the elasticity of the good/service.
ELASTICITY
Price Elasticity of Demand (PED)
Formula for PED:
% change in quantity demanded
% change in price
How do we calculate the % change???
Change in Quantity
Original Quantity
________________ (divided by)
Change in Price
Original Price
PED Example
• The price of a popular chocolate bar increases
from $3 to $4 per bar.
• The quantity demanded per week falls from
10000 bars to 9000 bars.
• Calculate the PED.
Change in Quantity = 1000
Original Quantity
10000 = .1
.1__
.333 = .3
What does this number
Change in Price =
1
= .3333
mean ? – the product is
Original Price
3
inelastic.
ELASTICITY
Price Elasticity of Demand (PED)
Unitary Elasticity
• If PED is exactly 1, this is know as unitary
elasticity, which means that a change in price
will lead to an identical change in quantity
demanded.
ELASTICITY
Price Elasticity of Demand (PED)
The Importance of PED for Business
• It is useful for business to look at PED when
deciding whether or not to change the price.
• Revenue (price x quantity) will be affected by
any change in price, but how it is affected
depends on whether a product is elastic or
inelastic.
ELASTICITY
Price Elasticity of Demand (PED)
PED is Inelastic (less than 1) =
Business Can Increase Revenue by Increasing Price
• They will lose some revenue from quantity
demanded, but will gain more revenue from the
higher prices, as demand changes less than
proportionally to the change in price.
ELASTICITY
Price Elasticity of Demand (PED)
PED is Elastic (Greater than 1) =
Businesses Can Increase Revenue by Lowering Prices
 They will lose some revenue from the lower prices,
but will gain more revenue from the higher quantity
demanded, as demand changes more than
proportionally to the change in price
 This means that businesses must be careful to
interpret their sales data correctly before making
decisions on price changes.
PED EXERCISES (1)
American Airlines (AA) decides to increase its
airfares on the Caracas to Miami route from $400
one way to $700 one way during December and
January. Weekly demands for the seats at this
price level falls from 10000 per week to 9500 per
week.
• Calculate the Price Elasticity of Demand (PED)
• Explain what the number means – are airfares on
this route at this time elastic or inelastic??
• From a revenue perspective was this a wise and
smart decision for AA.
PED EXERCISE (2)
APPLE decides to decrease the selling price of its
basic IPAD from $499 to $399. Weekly demand
in a specific market increases from 10,000 units
to 11,000 units.
• Calculate the Price Elasticity of Demand
• Explain what this number means
• From a revenue perspective, was this a wise/
smart decision for APPLE.
ELASTICITY
Income Elasticity of Demand (YED)
• YED measures the change in
demand for a product if there
is a change in consumers
income.
ELASTICITY
Income Elasticity of Demand (YED)
Formula:
% Change in Quantity Demanded
% Change in Income
How do we calculate the % change???
Change in Quantity
Original Quantity
________________ (divided by)
Change in Income
Original Income
ELASTICITY
Income Elasticity of Demand (YED)
Elastic Income Demand
• If demand is more than proportionally affected by
a change in income it is elastic.
• If incomes rises by 5% and demand increases by
20% it clearly is elastic.
• Income elastic goods are known as luxury goods.
• Expense jewelry is a good example – demand will
be significantly affected by changes in income.
ELASTICITY
Income Elasticity of Demand (YED)
• You would expect most goods to have a
positive relationship to income with demand
rising as income rises.
• After all, if you have more money you will
spend more. However, we need to
distinguish between two different types of
goods:
 Normal Goods
 Inferior Goods
ELASTICITY
Income Elasticity of Demand (YED)
Normal Goods
• Normal goods which will have a positive YED,
because more is demanded as income rises –
both the top and bottom of the calculation will
have the same size.
Inferior Goods
• Demand actually falls as income rises.
• The best examples are the low cost value ranges
stocked by most supermarkets.
• As income rises, instead of customers buying
more of these products, they may choose to
swap to a higher quality or brand alternative.
ELASTICITY
Income Elasticity of Demand (YED)
Inferior Goods
• These products are extremely popular in times of
recession and when incomes are falling, but are
quickly abandoned once incomes and
employment start to rise.
• The success of low cost chains across Europe such
as Lidl and Aldi will increase as the global
economy tips into a recession.
• As demand falls when income rises, the top and
bottom of the equation will have different signs
and therefore have a negative YED.
Income Elasticity of Demand (YED)
Exercise
The average middle income salary increases
from $50,000 to $70,000. The amount spent by
these consumers on restaurant meals (fine
dining) increases from $80 per week to $150.
• Calculate the YED.
• Explain the meaning of the number.
• Are restaurant meals a normal or an inferior
good? Why?
ELASTICITY
Cross Elasticity of Demand (XED)
• XED is a measure of
responsiveness of change in
the demand of one product to
the change in the price of
another (a complement or a
substitute).
ELASTICITY
Cross Elasticity of Demand (XED)
The formula is:
% Change in Quantity Demanded of Product A
% Change in the Price of Product B
How do we calculate the % change???
Change in Quantity A
Original Quantity A
________________ (divided by)
Change in Price of Product B
Original Price of Product B
ELASTICITY
Cross Elasticity of Demand (XED)
Substitutes
• Products that can replace each other
(substitutes) will have a positive XED – the
price of butter goes up, demand for margarine
will increase as some people choose to swap
to the option that has become relatively
cheaper.
ELASTICITY
Cross Elasticity of Demand (XED)
Complements
• Products that are linked (complements) have a
negative XED – as the price of airfares
increases, the demand for hotels in resort
locations may go down.
ELASTICITY
Cross Elasticity of Demand (XED)
No Relationship Between Goods
• Goods with no relationship will have an XED of
zero – for example if the price of cars
increases, demand for cheese will remain
unchanged.
ELASTICITY
Cross Elasticity of Demand (XED)
What does the number mean?
• The higher the number calculated, the stronger
relationship between the products, whether a
complement or a substitute.
Examples
• Coke and Pepsi are likely to have a very high,
positive XED as they are very close substitutes.
• Coke and Spirit will still have a positive XED, but it
is likely to be lower, as Spirit is alternative soft
drink, but not quite as close a match as another
Cola.
Cross Elasticity of Demand (XED)
Exercise
The number of subscribers to Super Cable
increases from 10,000 per month in September
to 11,000 per month in October. During
October Direct TV decided to increase the cost
of platinum TV package (all channels) from $60
per month to $80 per month.
• Calculate XED
• Explain the meaning of the number.
ELASTICITY
Advertising Elasticity of Demand (AED)
• Advertising elasticity of demand measures
how sensitive the quantity demanded is to
changes in an organization’s advertising
expenditure.
ELASTICITY
Advertising Elasticity of Demand (AED
AED formula:
% Change in Quantity Demanded
% Change in Advertising Expenditure
Change in Quantity
Original Quantity
________________ (divided by)
Change in Advertising Expenditure
Original Advertising Expenditure
ELASTICITY
Advertising Elasticity of Demand (AED)
Advertising Elastic
• If the AED is more than 1, it is known as
advertising elastic.
• The change in demand is more than
proportional to the change in advertising
expenditure.
Inelastic Demand
• An advertising elasticity of less than 1 is
referred to as advertising inelastic
ELASTICITY
Advertising Elasticity of Demand (AED)
Expectations with AED: Retail Goods
• You would expect most products to have a
positive AED as increases in spending should, all
other things being equal, lead to more demand
for a product.
• AED will be useful to businesses when deciding
how to promote a product.
• Retail goods (products sold to the general public)
tend to have a higher AED – changes in
advertising expenditure are likely to have a
significant effect on sales.
ELASTICITY
Advertising Elasticity of Demand (AED)
Expectations with AED – Industrial Matters
• The level of demand in industrial markets
(transactions between two businesses) is likely
to be less influenced by advertising as
businesses will be focused on the
characteristics of the product itself.
Advertising Elasticity of Demand: AED
Exercise
• The Atlantis Hotel & Resort complex in the Bahamas
decides to increase their yearly spending on advertising
from $10 million to $20 million.
• The number of hotels rooms demanded increases from
100,000 per year to 110,000 per year.
• Calculate the AED
• Is the product elastic or inelastic in regard to
advertising?
• Was does this mean?
• Was it a wise or a smart decision for the Atlantis Hotel
& Resort to implement this additional expenditure?