How Could Demand Elasticity Lead To Pricing Decisions?

How Could the Knowledge of Demand Elasticity Lead to Make Pricing Decisions? Making pricing decisions – Price sensitivity is not just about charging high prices to maximize revenue. It might also relate to cut prices – sometimes dramatically – to encourage people who may otherwise not be part of the market to use the services or goods being provided.

In business, it is like business of education, learning of price elasticity of demand. This concept is a cornerstone in any discussion of microeconomic principles and pricing for marketing effectiveness. Practically, price elasticity of demand involves the idea that consumers are affected by manipulations of price. On the producer part of view, price represents a distinct reflection of the production and marketing costs incorporated in bringing the product to the marketplace as well as the beginning point in the calculation of revenue and profit. On the consumer part, price is a critical ingredient in the image and value-conceptualization of a product.

Elasticity of demand is dependent on the knowledge of the determinants of demand and helps firms and policy makers plan of consumer behavior in the market place. Products that can be replaced are likely to have a positive cross price elasticity of demand because the change in price makes them relatively more or less expensive in relation to each other. Similarly co-relative goods will give rise to a cross price elasticity of demand value that is negative.

Strategic pricing clarifies the relationship between market segmentation and price, and delivers the tools your organization needs to stay focused on value as you determine break-even, define price elasticity, and analyze tradeoffs between features and price points. Using strategic pricing tools yields is a better positioning approach.

What I want to bring out here is a company director isn’t only concern about calculating numbers – profits. The number is a meaning at the end; when taking about price elasticity of demand it is used to see how sensitive the demand for a product is to a price change. The higher the price elasticity, the more sensitive consumers are to price changes. The very high price elasticity suggests that when the price of a product goes up, consumers will buy a great deal less of it and when the price of that good goes down, consumers will buy a great deal more. The very low price elasticity infers the opposite, that changes in price have little influence on demand.

When measuring elasticity, what is being measured is the responsiveness to demand to its determinants, such as income and other goods. This gives rise to income elasticity of demand and cross price elasticity of demand. Income elasticity measures the responsiveness of demand to a change in income. Cross price elasticity of demand measures the responsiveness of quantity demanded to a change in price of another good.

Demand elasticity of make pricing decision will define how the market will react to changes in price. Understanding of this will allow companies to make informed decisions on how should approach the final sale of the good which is achieved through marketing.

Background

Historically elasticity of demand thinking has been primarily applied to the marketing mix variable of price. However, the concept can also lend meaningful insights into the administration of the other marketing mix and environmental variables in a context of causality. There exists a rich body of literature exploring the more extensive uses of elasticity of demand. However, basic marketing texts, and presumably introductory classes, typically do not feature the wider applications of the tool.

At the beginning of 20 century, economist started to found out that demand consisted of more than simple purchasing power. It reverberate desire as well as ability to purchase, and new experiences with advertising and salesmanship were proving that desire could be increased and carved by factors other than the existence of supply. An extra idea of the market concerned its capacity to adjust itself automatically to an amicable balance. It had long been held that competitive forces would normally, in the long run, dissipate tendencies of unbalance, but as competition decreased in some industries and trades, the assumptions found in traditional economic theory became increasingly invalid. A third idea was that cost was the principal determinant of price, at least in the long run. Concepts of the elasticity of demand were still another influence upon the thinking of early marketing theory. Alfred Marshal’s concept of elasticity of demand has long been used by marketing writers as a theoretical basis for selling, advertising and the promotional work of marketing in general. (Fig 1.

Price Elasticity of Demand (PED) – It was devised by Alfred Marshall.)

Content

Price elasticity of demand is defined as the measure of responsiveness in the quantity demanded for products as a result of change in price of the same products. To say it in another way, its percentage change in quantity demanded as per the percentage change in price of the same products. In economics and in business, the price elasticity of demand is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity, which it is measures the relationship as the ratio of percentage changes between quantities demanded of a good and changes in its price. A price fall usually results in an increase in the quantity demanded by consumers. The demand for a good is relatively inelastic when the change in quantity demanded is less than change in price. Goods and services for which no substitutes exist are generally inelastic.

Marketing strategy focus on the decisions marketers make to help the company satisfy its target market and achieve its objectives. Price, of course, is one of the key marketing mix decisions and due to all marketing decisions must work together; the final price will be impacted by how other marketing decisions are made. Every companies view price as a key selling feature, but some firms, for example those seeking to be viewed as market leaders in product quality, will de-emphasize price and concentrate on a strategy that highlights non-price benefits e.g. quality, durability, service, etc. Such non-price competition can help the company avoid potential price wars that often break out between competitive firms that follow a market share objective and use price as a key selling feature.

Understanding how price changes impact the market requires the marketer have a firm understanding of the concept economists call elasticity of demand, which relates to how purchase quantity changes as prices change. Elasticity is evaluated under the assumption that no other changes are being made and only price is adjusted. The logic is to see how price by itself will affect overall demand. Obviously, the chance of nothing else changing in the market but the price of one product is often unrealistic. For example, competitors may react to the marketer’s price change by changing the price on their product. Despite this, elasticity analysis does serve as a useful tool for estimating market reaction therefore it leads to make pricing decisions.

Price elasticity of demand elasticity plays an important part when it needs to make piecing decision Marketing Essentials: economics knowledge to pricing from a marketing perspective (supply, demand, price elasticity).

And the knowledge of income elasticity of demand for different products helps firms predict the effect of a business cycle on sales as well. All countries experience a business cycle where actual GDP moves up and down in a regular pattern causing booms and slowdowns or even a recession. The business cycle means incomes rise and fall.

Elasticity deals with three types of demand scenarios:

(1) – Elastic Demand, (2) – Inelastic Demand and (3) – Unitary Demand.

For marketers the important issue with elasticity of demand is to understand how it impacts company revenue. Strategic Pricing define the relationship between market segmentation and price, and delivers the tools to the organization needs to stay adjusted on value as determine break-even, define price elasticity, and analyze tradeoffs between features and price points. Using strategic pricing tools yields a better positioning approach.

Opportunity cost is the cost expressed in terms of the next best alternative sacrificed. Opportunity cost is central to the whole study of both economics and business as it is at the heart of the decision making that characterizes the essence of both subject disciplines.

Value helps to explain why the demand curve slopes downwards from left to right. At higher prices, consumers have to sacrifice more utility (the satisfaction gained) from consuming other products. For some in a market, the price they are being asked to pay does not represent value for money – in other words they recognize that the sacrifice of other goods and services they have to make represents a negative impact on their utility.

This is all very theoretical but it is what we do when we make decisions about spending every day.

Elasticity varies among products because some products may be more essential to the consumer. Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases. Conversely, a price increase of a good or service that is considered less of a necessity will deter more consumers because the opportunity cost of buying the product will become too high.

Price elasticity of demand is defined as the measure of responsiveness in the quantity demanded for a commodity as a result of change in price of the same commodity. In other words, it is percentage change in quantity demanded as per the percentage change in price of the same commodity. In economics and business studies, the price elasticity of demand (PED) is a measure of the sensitivity of quantity demanded to changes in price. It is measured as elasticity, which is it measures the relationship as the ratio of percentage changes between quantity demanded of a good and changes in its price.

A price drop usually results in an increase in the quantity demanded by consumers. The demand for a good is relatively inelastic when the change in quantity demanded is less than change in price. Goods and services for which no substitutes exist are generally inelastic. Demand for an antibiotic, for example, becomes highly inelastic when it alone can kill an infection resistant to all other antibiotics. Rather than die of an infection, patients will generally be willing to pay whatever is necessary to acquire enough of the antibiotic to kill the infection.

The primary objective of a business is to provide quality products and services to customers, and through this to make a profit as a strongly related objectives measure. Many organizations fail to make an appropriate profit because they do not know how to price their products or services. Pricing is the critical element in achieving a profit and is a factor that all firms should seek to control. In order to set prices appropriately, a firm must understand their products, the market for these, production and distribution costs, and the competition. Especially with the growth of the Internet and electronic commerce networks, the marketplace responds very rapidly to technological advances and international competition. Thus, the need to be continually sensitive to the many factors that affect pricing, and to be ready to adjust organizational behavior appropriately, is greater than ever. Here, we present a literature review and overview of this important subject and related pricing decision support issues.

Conclusion

In my opinion, the theory behind price sensitivity is based on an understanding of the aims of an organization and the concepts of price elasticity of demand and consumer surplus.

Most private sector business organizations will need to make a profit to survive. This may not translate to a profit maximizing approach but nevertheless they will be looking to generate profits from activities. Part of this process will be looking at what happens to revenue. Revenue is the amount received from the sale of goods and services and is found by multiplying the price of a product by the quantity sold.

Price has an important function in markets. It acts as a signal to both producers and consumers. For producers it gives them some indication about the returns they can expect from sales in relation to their costs – in other words whether it is worth producing a good or not. For consumers it provides an indication about value. Value is a very important concept in economics and business. It is difficult to define because we all have a different interpretation of what value means. In essence, the value we place on a good or service is indicated by the price we are willing to pay to consume that good or service.

Price sensitivity therefore is important to all businesses when considering their pricing strategies. They will need to have some understanding of how their market will react to changes in price and thus what the impact is on their revenue. Understanding of this will allow companies to make informed decisions on how should approach the final sale of the good which is achieved through marketing.