Elasticity Of Demand And Economics Decision Making Economics Essay

Extent or degree to which a demand or supply curve reacts to the change in price is called elasticity of that curve. This nature of curve varies with different nature of products means if a product is essential then change in price does not effect much on demand. On the other hand less essential product are quite sensitive to the price changes because opportunity cost of buying those product become too high.

A good or service is said to be highly elastic if slight change in price leads to a sharp changes in quantity demanded or supplied. There are lots of products in the market which are not needed in our routine life. And a good or service is said to be highly inelastic if changes in price doesn’t effect much on the quantity demanded or supplied. These are those product or services which are very much essential to our daily life.

Price Elasticity of Demand

It is defined as the percentage change in quantity demanded to the percentage change in price for a particular product or service. Demand is said to be elastic if change in price leads to a higher change in demand, in that case Price Elasticity of Demand (PED) would be more than one i.e PED > 1

P P

D

D

Elastic demand PED>1 Q Perfectly Elastic Q

Goods which comes under elastic category tend to have following characteristics

They are luxury goods.

They are very expensive like sports cars.

Goods bought frequently.

Goods with many substitutes in market.

Price Inelasticity of Demand:

Demand is said to be inelastic if the percentage change in price doesn’t affect much on the demand of a product i.e. PED < 1

P P

Inelastic demand PED<1 Q Perfectly inelastic PED=0 Q

Goods which come under inelastic category tend to have following characteristics:

They are necessities.

People are use to them means they are addictives like wine & cigarettes.

They have no or very few substitutes like petrol.

They cost a small percentage of income and bought infrequently.

In the short demand is usually more inelastic because it takes time to find alternatives. We can say if the price of chocolate increased demand would be inelastic as there is no alternatives, however if the price of mercury increased there are close substitutes in the form of other chocolates. Therefore demand would be more elastic.

In broad there are three factors influencing the demand’s price elasticity:

The availability of substitutes: This is the most important factor influencing the elasticity of a good or service. In general speaking more the substitutes the more elastic the demand will be.

Income available to spend on goods: This factor affecting demand elasticity refers to the total a person can spend on a particular good or service. Now suppose price of orange juice goes up from $2 to $3 and the income remains the same. So the income that is available to spend on orange juice which is say $12 is enough for only 4 cans rather than 6. In other words consumer is forced to reduce his demand of orange juice. So if there is increase in price and at the same time no increase in available amount for that good or service then there will be elastic reaction in demand. Therefore demand will be sensitive to a change in price if there is no change in income.

Time: Another important factor is time. If price of cigarettes goes up by 15%, a smoker with very few substitute start buying on daily basis instead of buying for a week or so. This suggests that tobacco is inelastic because change of price will not have a considerable influence on the quantity demanded. However if the smoker finds difficult to spend extra 15% and begins to get rid off smoking, the price elasticity of cigarettes for that consumer become elastic in long run.

Market Structure:

Every market has his own features on which it works or behaves. There are few features which we should consider while determining the market structure as

First of all we should know the awareness of consumer about the market. We should know how knowledgeable our customers are.

We should know how many firms are doing the same business; it tells us the extent of competition we are supposed to face.

What type of product we are dealing with, whether it is coming in the category of necessary product or in the category of luxury product.

Whether the entry in the market is easy or difficult and same is the case with leaving the market.

Based upon these factors we decide whether the market is perfectly competitive or imperfectly competitive. In a perfectly competitive market there is no entry and exit barrier, we can enter or exit at any point of time from the market. Also in perfectly competitive market product is homogenous and there are large number of buyers and sellers. While in imperfectly competitive market there are very few buyers and sellers, very difficult to enter into and exit the market and at the same time there is monopoly of product.

Market Structure of Airline Industry:

Market structure which suits to Airline Industry is oligopoly market. In this type of market there are only 2-3 firms who dominate the market. Advertisement and marketing is very important in such type of markets. As there are very few firms, they know each other very well. They know strategies of each other. So they always consider their competitors, while making price strategies, because they just can’t set the prices by themselves. They have to consider the pricing of their competitors as well. Although when one firm has a dominant position in the market the oligopoly may experience a price leadership. Firm having lower market share may forced to follow the pricing policy of dominant firm. As large amount of fixed cost is involved in this type of market so entry as well as exit is very difficult. There are basically three major theories about the oligopoly of pricing as under:

These firms collaborate to charge the unique price and at the same time unique profit.

These firms compete on price so that price as well as the profit will remain same as in competitive market.

These firms had the price and profit in between of perfectly competitive and monopoly markets.

Market Structure

Seller Entry

Barrier

Buyer entry

Barrier

Number of

Seller

Number of

Buyers

Perfect competition

No

No

Many

many

Oligopoly

Yes

No

Very few

many

Monopoly

Yes

No

Only one

many

Table for different market structure

Yield Management:

The basic concept of yield management is to provide right service to right person at the right price on right time. (Kimes, 1989: Weatherford and Bodily 1992). Now in case of Airline Industry we can define yield management as generating maximum revenue per seat by keeping customer satisfied. We can do this by applying different policies. As in every industry, customer is very important in this industry. Customer is paying quite an amount to get the services of this type of industry. So we have to take a very good care of customer as well. We have to provide good service right from the booking of ticket to leaving off the plane.

The strategic points of yield management are four C’s namely, calendar, capacity, clock and cost and they all bound together with another C i.e. customer.

Singapore Airlines is a great example of this. They take a great care of their customers. They keep data of each and every passenger travel with them. They not only provide excellent service but also maintain good and caring relations with customers.

Firms compete for market share and demand from customers in many ways. We differentiate these ways into two major subheads i.e. Price Competition and Non-price Competition. We are considering New Zealand Airline Industry as an example

Price Competition:

Price competition involves increasing the demand by discounted the price. We increase our business in different ways as under:

We can provide discounted tickets in the off seasons. We can provide ticket through some scheme like buy one ticket and get 50% discount on purchase of another ticket. This would definitely attract customers and at the same time would increase the revenue. Because there is no use of flying with vacant seat, its better to have customers with discounted tickets.

We can also start pre booking scheme especially for our off season. We can launch scheme like discount on ticket booked 1-2 months before. This would enable us to know how much customer we have in our off season and we can make our further strategy according to that. If we still have very few bookings then we can offer some gifts, holiday package or so on booking to boom our sale. We can introduce new packages with our tickets. We can collaborate with few hotels to provide a complete holiday’s package to family, newly married couples & teenagers.

We can provide one way free travel, means a person can pay for one way and get the ticket for return as well. This will increase the revenue and at the same time enable us to get few loyal customers.

Non- Price Competition:

This is the focus on other strategies to increase the market share. There are various strategies which comes under this category as

Advertisement and marketing is the major strategy which comes under this category. As there is huge investment involve in this type of industry so we want to get super normal profit out of this. Advertisement plays an important role in achieving this. We advertise and market our product or service in such a way that it put significant impact on customer.

On line booking is another value added service. We can book our ticket from home and get our seat confirmed. This would help customer to make his plan well in advance and at the same time it is hassle free. This would enable them to get rid off agents as well as long queue. And apart from this it is 24 hours service.

Locality card or points given to every customer, who keeps on adding and customer, will get a prize on reaching certain points. This enable customer to interest for his next trip from same airline.