Marketing Analysis: Elasticity (Copy)

8.1 Marketing Analysis

8.1.1 Elasticity

1. Concept Of Elasticity Of Demand

• Elasticity of demand measures the responsiveness of demand to a change in another factor.
• It is expressed as a ratio of percentage change in quantity demanded to percentage change in a determinant.
• Types of elasticity relevant in business:
  • Price Elasticity of Demand (PED).
  • Income Elasticity of Demand (YED).
  • Promotional Elasticity of Demand (PrED).

2. Price Elasticity Of Demand (PED)

• Definition: Measures the responsiveness of demand to a change in price.

Formula:
PED = % ΔQd% ΔPfrac{% ΔQ_d}{% ΔP}

Where:

• % ΔQd=Q2−Q1Q1×100% ΔQ_d = frac{Q₂ – Q₁}{Q₁} × 100
• % ΔP=P2−P1P1×100% ΔP = frac{P₂ – P₁}{P₁} × 100

Types Of PED:

• Elastic Demand (PED > 1)
  • Demand changes more than proportionately to price.
  • Lowering price increases total revenue.
  • Example: Luxury clothing, non-essential goods.
• Inelastic Demand (PED < 1)
  • Demand changes less than proportionately to price.
  • Increasing price increases total revenue.
  • Example: Petrol, cigarettes.
• Unitary Elastic Demand (PED = 1)
  • Percentage change in demand = percentage change in price.
  • Total revenue unchanged.

3. Income Elasticity Of Demand (YED)

• Definition: Measures responsiveness of demand to changes in consumer income.

Formula:
YED = % ΔQd% ΔYfrac{% ΔQ_d}{% ΔY}

Where:

• % ΔQd=Q2−Q1Q1×100% ΔQ_d = frac{Q₂ – Q₁}{Q₁} × 100
• % ΔY=Y2−Y1Y1×100% ΔY = frac{Y₂ – Y₁}{Y₁} × 100

Types Of YED:

• Normal Goods (YED > 0)
  • Demand increases as income increases.
  • Luxury goods: YED > 1 (elastic).
  • Necessities: 0 < YED < 1 (inelastic).
• Inferior Goods (YED < 0)
  • Demand decreases as income increases.
  • Example: Instant noodles, bus travel, second-hand goods.

Business Use:

• Helps forecast sales in economic growth or recession.
• Assists in product portfolio decisions.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course

4. Promotional Elasticity Of Demand (PrED)

• Definition: Measures responsiveness of demand to changes in promotional expenditure.

Formula:
PrED = % ΔQd% ΔEfrac{% ΔQ_d}{% ΔE}

Where:

• % ΔQd% ΔQ_d = percentage change in demand.
• % ΔE% ΔE = percentage change in advertising/promotion spending.

Interpretation:

• High PrED (>1) → sales respond strongly to promotional spending.
• Low PrED (<1) → promotions have limited effect.

Example:

• Fast-moving consumer goods (soft drinks, snacks) often have high PrED.
• Essential medicines may have low PrED (demand does not depend on advertising).

5. Interpretation Of Elasticity Results

• PED > 1 (Elastic) → cut price to increase revenue.
• PED < 1 (Inelastic) → raise price to increase revenue.
• YED > 1 → luxury goods, sales rise faster than income.
• YED < 0 → inferior goods, sales fall when income rises.
• PrED > 1 → advertising is effective.
• PrED < 1 → advertising has little impact.

Numerical Example (PED):

• Price rises from 10 to 12.
• Demand falls from 100 units to 80 units.
• % ΔQd=80−100100×100=−20%% ΔQ_d = frac{80 – 100}{100} × 100 = -20%.
• % ΔP=12−1010×100=+20%% ΔP = frac{12 – 10}{10} × 100 = +20%.
• PED = (-20%) ÷ (20%) = -1 → unitary elastic.

6. Impact Of Elasticity On Business Decisions

A. Pricing Decisions

• Elastic demand (PED > 1) → reduce prices to increase total revenue.
• Inelastic demand (PED < 1) → increase prices to raise revenue.

B. Marketing Strategy

• If PrED is high, increase promotional spending for sales growth.
• If low, reduce advertising to save costs.

C. Product Portfolio Strategy

• High YED products → invest in luxury goods during economic growth.
• Negative YED products → focus on essentials during recessions.

D. Forecasting Sales And Planning

• Helps predict impact of changes in price or income.
• Assists in setting sales targets and budgets.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change O Level And IGCSE Accounting Full Scale Course

7. Limitations Of Elasticity In Business

• Difficult To Calculate
  • Requires accurate data on prices, income, and demand.
• Assumes Ceteris Paribus
  • Other factors (competitors, tastes, substitutes) may change at the same time.
• Time Lag
  • Consumers may not respond immediately to price or income changes.
• Different Market Segments
  • Different groups of customers may have different elasticities.
• Not Always Reliable For Future
  • Past data may not predict future behaviour accurately.

Equation Limitation:

• Elasticity depends on historical data:
  • PED=% ΔQd% ΔPPED = frac{% ΔQ_d}{% ΔP}
  • If future consumer behaviour differs, prediction becomes inaccurate.

8. Real-World Examples

• Luxury Cars (BMW, Mercedes) → High YED, demand rises more in booming economies.
• Public Transport → Negative YED, demand falls as incomes rise (people buy cars).
• Coca-Cola Advertising → High PrED, promotions directly boost demand.
• Oil And Petrol → Low PED, demand remains even if price increases.
• Apple iPhones → Relatively inelastic demand, high brand loyalty allows higher prices.

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course

9. Quick Revision Tables

A. Price Elasticity Of Demand (PED)

B. Income Elasticity Of Demand (YED)

C. Promotional Elasticity Of Demand (PrED)

Written and Compiled By Sir Hunain Zia, World Record Holder With 154 Total A Grades, 7 Distinctions and 11 World Records For Educate A Change A2 Level Business Full Scale Course

10. Key Evaluation Points For Exams

• Elasticity is a guide, not a guarantee.
• Use elasticity to support strategic decisions (pricing, promotion, product development).
• Elastic demand products → good for price competition.
• Inelastic demand products → firms can raise prices without losing many customers.
• YED helps firms prepare for economic cycles (luxury vs necessity goods).
• PrED helps allocate marketing budgets effectively.
• Limitations:
  • Data may be unreliable or outdated.
  • Consumers may not behave rationally.
  • Market changes may distort elasticity values.
  • Not all products have measurable elasticity.

11. Example Exam Application

Question: A business selling designer handbags finds its PED = 2.5. Should it raise or lower its price?

Answer:

• PED > 1 = elastic.
• Lowering price will increase demand by a greater proportion than the fall in price.
• Total revenue will increase.