Price & Income Elasticity of Demand

measures the extent to which demand for a product changes when there is a change in a causal variable, such as price or consumer incomes.

Price Elasticity (PED) =

% change in quanitity demanded

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% change in price.

Price elasticity measures the percentage effect on demand of each 1% change in price.

• Above 1 = price elastic. (IGNORE -)
• Between 0 and 1 = inelastic.

• The degree of product differentiation = extent to which customers view the product as being distinctive from it's rivals.
• The availability of substitutes = customers may see 7UP and Sprite as very similar drinks and substitutes for each other, if one brand changed their price and it was too expensive, they consumer would chose the cheaper one.
• Branding & brand loyalty = products that are price inelastic are created by strong brand names with strong brand images and create customers who buy out of loyalty.

Sales Forecasting:

• Producing a sales forecast will make possible accurate production, personnel and purchasing decisions.
• Using the price elasticity of demand helps businesses to discover likely impacts of future prices.
• Information is then passed on to HR and operations so they can alter staff numbers and stock according to the change.

Pricing Strategy:

• PED can be used in conjuction with internal cost data in order to forecast the impact of change on the firm's revenue.

Price elastic products =

• Characteristics: undifferentiated, many competitors.
• Impact of a price cut: sales rise sharply, along with revenue.
• Numerically = above 1 (or below -1)
• Impact of a price rise: sales fall sharply, along with revenue.

Price inelastic products =

• Characteristics = differentiated, few competitors.
• Impact of price cut = sales rise but not so much, revenue falls slightly.
• Numerically = between 0 and 1 (or 0 and -0.99)
• Impact of price rise: sales fall but not so much, revenue rises slightly.

% change in demand

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% change in real incomes (incomes after inflation)

• Normal Good = positive income elasticity and YED between 0.1 and 1.5.
• Luxury Good = very positive income elasticity and YED of more than 1.5.
• Inferior Good = negative income elasticity (as people become richer they buy less of it) e.g. Sainsbury's basics.

• Inferior goods sell well during recessions, therefore it is good for a company to sell both inferior and luxury goods.

• The UK economy tends to grow at around 2.5% a year in the long term and normal and luxury goods are the most important part of a long term strategy.

Pricing low with the deliberate intention of driving a competitor out of business.