Factors that Influence the Price Elasticity of Demand
Price elasticity of demand (Ed) evaluates responsiveness of product quantity demanded as a result of change in price, ceteris paribus. Ed is measured as:
Factors affecting price elasticity of demand include: substitutes, level of necessity, income proportion, time and price points.
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Availability and number of substitutes affect elasticity of demand. Products that have substitutes tend to have a higher degree of price elasticity and the higher the number of substitutes, the more elastic the demand (Zheng, Kinnucan & Kaiser 2010). Demand for product X is price sensitive to change in price for product Y if both have a common utility.
Nature of commodity affects elasticity of demand. Necessity products have low elasticity of demand when compared to luxury products. This is related to a customer’s willingness to pay for a certain product at a certain price (Johnson & Myatt 2006). Consumers are more likely to purchase necessity products even when price rises whereas for luxury items is likely to reduce quantity bought as the opportunity cost will rise significantly.
Income proportion of the commodity affects demand elasticity. The income proportion of a product refers to the amount a consumer is willing to spend on a particular product. Commodities that take up a large percentage of a consumer’s total income generally have a high elasticity of demand (Baumol & Blinder 2011). Essentially, the rise in price with no accompanying rise in income results to high elastic demand.
Other factors affecting price elasticity of demand include time and price points. The more the time under consideration, the higher the elasticity as in the long-run, elasticity is higher as consumers take the time periods to adapt their behavior in response to price changes. Price points involve a psychological approach that tunes the consumer to perceive price change at a certain level to be more appealing. For instance, reducing price of a product from $3.00 to $2.99 is likely to raise the quantity demanded when compared to a decrease from $2.99 to $2.98.
Reasons and ways advertisers change consumer demand and effects on demand curve
Advertisements are designed to entice and encourage consumers to obtain, or increase the amount of a commodity that they consume by changing behavior. The change in behavior might involve the manner of consuming a product, to convince on superiority of a certain product, and to alert on a change or uniqueness of a product. Essentially, advertisements, by influencing customer’s tastes and preferences aims to shift demand curve to the right or to rotate the curve in a way that reduces price elasticity of demand (Johnson & Myatt 2006). The effect on the demand curve is dependent on the type of advertisement. Johnson and Myatt (2006) argue that hype advertising shifts demand curve whereas informative advertisement rotates the demand curve.
Figure 1: Demand curve shifts
Figure 1: Demand curve shifts
In the graph above (Figure 1), advertisement shifts overall demand for the commodity from D to D1 shifting the demand curve to the right. A typical case of this is when advertisement is aimed at providing information to the consumer. In this case, more quantities of the commodity are demanded for a specific price. As demand rises, and because supply is constant, firms are willing to supply the extra quantities only at higher prices, thus the price rises.
Although not widely agreed, some authors have proposed that advertisement can rotate the demand curve thereby affecting price elasticity. For instance, Zheng, Kinnucan and Kaiser (2010) argue that advertising can result to a rotation of the demand curve counterclockwise in the case where it emphasizes product’s substitutability by others, or clockwise by emphasizing the product’s uniqueness. A study by Chung and Kaiser (as quoted in Zheng, Kinnucan & Kaiser 2010) found that generic advertisement lowered demand elasticity.
Although advertisement is meant to shift demand, it costs the organization but the nature of this cost is determined by whether it affects marginal cost of production or if it is a fixed cost (Zheng, Kinnucan &Kaiser 2010).
Figure 2: Rotation in demand curve
In the graph above (Figure 2), advertisements resulted to a not only a shift in demand (from D to D1) to the right but also a reduction in price elasticity. With the assumed inelastic price elasticity to demand (D1), and rise in price would raise revenue (Erdem, Keane & Sun 2007).
Although the common assertion is that advertising raises demand, it can also reduce demand especially in cases where it leads to higher prices for the firm (Schoonbeek 2007). In addition, due to the cross-effects in an industry, advertising in one firm can have either a positive or negative effect on the demand for another firm’s products.
Real-Life Examples of Advertisements and the aims of Strategies
Coca Cola applies varying media including print, TV commercials, and billboards. In addition, they employ different promotion strategies including strategic shelf display, sales promotions, and sponsorships. In some countries, the company reduces the price of their products during the cold seasons in a bid meant to retain customers. The company uses emotional appeal to attract the audience to its products in a way that satisfies specific human needs. In the slogan and commercials “open the coke side of life” for instance, the advertisements places the product as satisfying a certain need to live, affiliation and as offering meaning to life. This is meant to have an emotional appeal to the target audience thus encouraging them to buy more of the product thereby increasing demand. These are meant to shift the demand curve thereby increasing the quantity of products demanded and to reduce price elasticity for demand. According to Johnson and Myatt (2006), the approach used by Coca Cola is hype advertising and this is more likely to shift the demand curve rather than rotate it.
The “Got Milk” advertising campaign ran by California Milk Processor Board was meant to raise demand and consumption of milk. The advert was informative in nature, generally meant to highlight the importance of milk to the consumer. Advertisement for milk is meant to increase demand and reduce elasticity for demand. According to Johnson and Myatt, advertisement for milk, which is more informative, is more likely to rotate the demand curve thereby affecting price elasticity for demand than to shift demand.
The Costs and Benefits of Such Market Strategies to the Consumers and Supplier
Marketing strategies are beneficial to the consumer. Understanding how advertising affects demand curves is important for advertising decisions, planning and program evaluation (Zheng, Kinnucan & Kaiser 2010). By focusing on a specific market, a company is able to clearly identify the needs of this market segment and therefore make efforts to customize the product or service to meet this need. For instance, by Kodak focusing on a differentiated market strategy, the company is able to produce customized products for a specific market segment and respond appropriately to such aspects as price and quality. Consumers therefore obtain products that meet their needs. By adopting such market strategies, several benefits accrue to the supplying company. The organization uses its resources more effectively, becomes more competitive in the market place, and is better able to satisfy and retain its customers. Costs to the consumers include exclusion in case where the said consumer is not within the targeted segment, in which case product features may not be responsive to the desired needs (Rogers 2001).
Baumol, W & Blinder, A 2011, Economics: Principles & Policy, 12th ed, , South-Western Cengage Learning, Mason, OH
Erdem, T, Keane, M & Sun, B 2007, The impact of advertising on consumer price sensitivity in experience goods markets, Quantity Market Economics, DOI 10.1007/s11129-007-9020-x, accessed <http://ckgsb.edu.cn/userfiles/doc/ck_faculty_bhsun_adandpricesensitivity.pdf>
Johnson, J & Myatt, D 2006, On the simple economics of advertising, marketing and product design, The American Economic Review, vol. 96, no. 3, pp.756-784
Rogers, S 2001, Marketing strategies, tactics, and techniques: A handbook for practitioners, Greenwood Publishing Group, Inc, Connecticut, USA
Schoonbeek, L 2007, The impact of advertising in a duopoly game, International Game Theory Review vol. 9, no 4, pp. 565-581
Zheng, Y, Kinnucan, H & Kaiser, H 2010, Measuring and testing advertising induced rotation in the demand curve, Applied Economics vol. 42, pp. 1601-1614