1. Demand and Revenue Management
CHAPTER 12
Demand and Revenue
Management
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2. Price, Sales, and Consumer Choice
Profit
Revenue minus cost
Revenue
Depends on the customer
Consumer behavior - making choices
Choices reveal preferences
If people spend money on something and not on something else
Revealing their preferences
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3. Price, Sales, and Consumer Choice
Law of demand
The quantity of a good or service that is purchased
Will decline as the price of that good or service rises
Everything else unchanged
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4. Elasticity Price elasticity of demand The more price-elastic demand is
Magnitude by which consumers alter the quantity of some product they purchase
In response to a change in the price of that product
The more price-elastic demand is
The more responsive consumers are to a price change
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5. Elasticity Price elasticity of demand ed = %ΔQ / %ΔP
Percentage change in the quantity demanded of a product
Divided by the percentage change in the price of that product
ed = %ΔQ / %ΔP
%ΔQ = percentage change in quantity demanded
%ΔP = percentage change in price
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6. Elasticity Price elasticity of demand Demand curve
If between -1 and - ∞: elastic demand
If = -1: unit elastic demand
If between -1 and 0: inelastic demand
Demand curve
Illustrates the quantity of an item that will be purchased at each price
Relationship between the price and quantity demanded of a good or service
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7. Elasticity Shape of a demand curve Perfectly elastic demand curve
Depends on the price elasticity of demand
Perfectly elastic demand curve
Horizontal line
Consumers can purchase any quantity they want at the single prevailing price
Even the smallest price change
Consumers switch to the producer with the lowest price
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8. Elasticity Perfectly inelastic demand curve
Vertical line
Consumers cannot or will not change the quantity of a good they purchase when the price of that good is changed
Downward sloping demand curve
The steeper – the less elastic
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9. Figure 12.1
Demand Curves
The demand curve is a graphic relationship between quantity demanded and price. The graph is drawn with price on the vertical axis and quantity on the horizontal axis. (a) Perfectly elastic demand: Demand is so sensitive to price that even an infinitesimal change leads to a total change in quantity demanded. (b) Perfectly inelastic demand: The quantity demanded is the same no matter the price. Demand is completely insensitive to price. (c) Alternative demand curves: and D2 represents straight downward-sloping demand curves. D2 is said to be more elastic than D1 because at every single price the elasticity of demand is higher at D2 than D1.
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10. Elasticity Price Elasticity and Revenue
Total revenue, TR = P × Q
Dollar value of sales
Price of a product multiplied by the quantity sold
As price is increased, total revenue:
Increases if demand is inelastic
Decreases if demand is elastic
Does not change if demand is unit-elastic
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11. Elasticity Elasticity of demand depends on
How many substitutes and how good of substitutes they are
More substitutes – more elastic demand
Commoditization – price elasticity of demand is very large
Period over which we measure the price elasticity
Longer – more elastic demand
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12. Figure 12.2 Changing Price Elasticity
Demand is perfectly elastic for Demand1. The firm cannot charge more without losing all of its customers because the product is a commodity—there are many perfect substitutes. The firm undertakes an advertising campaign to change the image of the product. If successful, consumers begin to think the product is not a commodity, that there are not lots of perfect substitutes. The demand curve then becomes steeper, as with Demand2.
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13. Business Insight Price Elasticity of Demand for Gasoline
Price elasticity of demand for gasoline, US
Over a period of one year or less = −0.26
10% hike in the price of gasoline lowers quantity demanded by 2.6%
Long-run = −0.58
10% hike in gasoline causes quantity demanded to decline by 5.8%
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14. Business Insight Price Elasticity of Demand for Gasoline
10% increase in real price of fuel
Volume of traffic decline
By 1% within a year
By 3% in longer run (5 years)
Volume of fuel consumed decreases
By 2.5% within a year
By 6% in the longer run
Efficiency of use of fuel increases
By 1.5% within a year
By 4% in the longer run
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15. Other Demand Elasticities
Other elasticity measures
Income elasticity of demand
Cross price elasticity of demand
Advertising elasticity
Promotion elasticity
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16. Figure 12.3 Changes Other than Price
The demand curve is a relation between price and quantity demanded, everything else held constant. The things held constant are income, advertising, expectations, tastes, preference, and anything else that could affect demand. When one of these changes, the demand curve shifts. For instance, Demand2 represents demand following an increased income. The distance the demand curve shifts is reflective of the income elasticity of demand.
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17. Other Demand Elasticities
U.S. economy
Has grown over the years
The growth has not been at a steady pace
Business cycles
Upswing in business activity
Incomes are growing
Sales of many products are rising
Downswing
Incomes are not rising
Sales may be declining
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18. Figure 12.4 Economic Growth and the Business Cycle
The real output or GDP of the U.S. economy each year is pictured. The picture points out two things: The total output has grown over the years, and the growth has not been a steady rise.
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19. Figure 12.5
Business Cycle
Taking out the growth part of Figure 12.4 leaves just the cycles.
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20. Other Demand Elasticities
Income Elasticity of Demand
Responsiveness of consumer purchases to income changes
Percentage change in demand
Divided by the percentage change in income
Everything else held constant
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21. Other Demand Elasticities
Luxury good
Very high income elasticity (>1.0)
1% increase in income will lead to a greater than 1% rise in demand
As long as the economy is growing
And incomes are rising
Sales are rising
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22. Other Demand Elasticities
Normal good
Positive but <1 income elasticity
As income rises, demand rises
Cyclical goods
Inferior good
Negative income elasticity
As income rises, demand falls
Countercyclical goods
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23. Other Demand Elasticities
Complements
Items used together
Substitutes
Items used in place of each other
Cross elasticity of demand
Measures whether goods and services are complements or substitutes
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24. Other Demand Elasticities
Cross elasticity of demand
Percentage change in demand of one good
Divided by the percentage change in the price of a related good
Close substitutes: high positive cross elasticities
Complements: negative cross-price elasticities
Unrelated goods: zero cross-price elasticity
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25. Elasticity Estimates Computer technology
Much better information about customers and the elasticities of demand
Enabling many “low-margin” industries to improve their margins
By knowing their customers better
Firms are increasing profits because they better understand the customer
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26. Elasticity Estimates Elasticity models
Daily evaluation of pricing factors
Site by site
That are stored on a running database
Historical price, volume, and competitive data
Continual fine-tuning accomplished through daily data updates
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27. Elasticity Estimates Gasoline - typical elasticity estimates
For a single retailer
According to the pricing company MPSI Systems Inc.
6 for regular
4.5 for mid-grade
3 for premium
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