M03EFA: ECONOMIC ENVIRONMENT OF BUSINESS

(October 2011)

AN ESSAY ON OWN PRICE AND INCOME ELASTICITY DEMAND

Shreenath Nair (ID: 3989438) (MBA General Management)

Module Leader: Dr. Keith Gray

INTRODUCTION

The decision which deals with the setting of price for a particular product is considered very crucial for a companys success. The understanding of the responsiveness of the change of price of the products is inevitable for a products success. The main objectives of a firm can only be fulfilled if a best price is decided for its products .Many firms fail to consider the critical concept of changing demands with changing price. The proper pricing strategies in an organization leads from proper management activities within the organization .The crest and trough in the profits of an organization is the direct measure of efficient and poor management respectively. The economists view towards any business with respect to pricing strategies always boils down within the conceptual framework of price elasticity and how each elements associated with it changes with changes in external and internal factors. A deeper analysis of own price elasticity and income price elasticity has to be brought about in an organization while dealing with decisions on price setting.

THEORY

The sensitivity of the consumers towards a price change , with respect to different markets, is different . This reaction is measured using elasticity (Begg and Ward 2009:29) . Price elasticity of demand is a measure of the responsiveness of demand for a product to a change in its own price(Griffiths and wall 2011: 40)

Price elasticity of demand (PED) = Percentage change in quantity demanded Percentage change in price The Price elasticity of demand helps to determine the change in demand if the price of a product is increased or decreased with respect to organizational strategies and targets. The important elasticity measures is brought out by different elasticity values which can be described as perfectly inelastic demand , inelastic demand , unit elasticity demand, elastic demand and

perfectly elastic demand for PED values of 0 , <1 , 1 , >1 and infinite respectively .The key price elasticity of demand determinants are ,the product life cycle , the proportion of income spent and the number/ closeness of substitute goods.

The income elasticity of demand measures the responsiveness of change in demand to a change in income in percentage terms.

Income elasticity = Percentage change in demand Percentage change in income If the income elasticity measure is < 1 then the product is supposed to be income inelastic and the demand doesnt vary significantly with changing income levels of the consumers .If it measures >1 then the product is said to be income elastic which means the change in income levels causes radical changes in the quantity of demand .

CONCEPT

The total revenue will increase if the rate at which the demand decline is comparatively lower than the rate at which the price is changed .The consumers will demand less quantity of a particular product for which the price is set high .The proper price of the products should be set by analyzing the demand curve which gives the forecast of the response change in demand with change in price.

Figure 1 : The Demand Curve

It is evident from the demand curve that if the price of a product is increased slightly from P2 to P1then it will result in a massive decrease in demand (shift from D to C) where the demand curve is said have high price elasticity . On the other hand, the demand curve with low price elasticity will result in comparatively less decrease in demand with slight increase in price. Know your customer. This phrase means understand the demand curve and know the values of elasticity measures (Boyes, 2004: 77)

APPLICATION

The concept of own price elasticity and income price elasticity demand has predominant application in various firms . BSA guns is one of Britains important industrial groups .This group started as a small union of gun smiths in 1689 and carried many munition works and manufacturing rifles are their main activities .Although, munition works were given up lately and the company owned factories in Coventry, Birmingham, Redditch , Sheffield and Co. Durham along with many dispersal units and shadow factories was in operation (BSA guns 2011). After the Coventry Blitz BSA guns stopped its supply to military armed forces and now manufactures air rifles , sports guns and hunting rifles and exports 557 products to different countries in the world.

BSA guns skim most of its initial revenue by setting a high price for its products for export and local sales. The reputation of BSA is deeply rooted in UK because it is considered as an important industry group in UK and BSA guns uses their brand power towards their high price strategies. The variations in the economy of UK has direct effect on the buying power of its customers and it has been seen recently that the economy of UK is dwindling down . The air rifles , hunting guns and sports guns are products whose demand can vary significantly with slight increase in price under the conditions of economy downturn. The selection of best price is the greatest challenge for any company because it decides the future of the product. The knowhow of the concept of own price elasticity demand and the income price elasticity demand is very important for BSA guns because the economy variations are very much prevalent in UK.

The mean income per week for the year 2009-10 was 517 pounds which was earned by individuals who were just under a million in number .The analysis of the income distribution helps to determine the best price which can be set for the guns of BSA so as to target maximum sales .In 2009 -10 the UK economy was struggling which resulted in the change in the income distribution and also changed the gross domestic product values .BSA guns should be aware of the buying power of its customers so as to maintain the steady flow of guns .The rise in unemployment during the recession years in UK affects the pricing strategies of an organisation and UK is under the threat of another forecasted recession in near future , hence it becomes mandatory for the firms to study their sales and review their strategies inorder to achieve the set milestone. From May 2008 to May 2009 the unemployment level in UK increased radically from 1.61 million to 2.38 million and for most of the time in year 2010 the unemployment level hovered just below 2.5 million (Economic Review 2010). In UK the level of unempoyment has almost reached a steady value but the duration of unemployment has increased which is an indication of the decline in the buying power of the consumer and the dimnishing consumer surplus.It has become a neccessity for an organisation based in UK to study the trends of changing economy inorder to fix a price for its products which will increase the sales and where comes the concepts of own price and income elasticity of demand in to picture.BSA guns being based in UK has to consider theses crucial concepts of economics which allows efficient management outcomes to be implemented effectively.BSA guns has variety of products which includes different types of barrels, rifles spring guns , rifles precharged ,pellets, scope mounts, gun safes , silencers and adaptors , torch and laser set and foldaway target holder. The target sales of these products can be achieved if the demand of these products can be forecasted approximately which eventually depends heavily on the core products ,which are air rifles and sports guns , whose sales generates potential for the sale of other relative products .During the recession In UK nearly 1 million jobs were lost and the Consumer Price Index (CPI) reached 3.2 and the monthly changes in its values indicated the change in the short term prices of food , beverages, tobacco , fuel , footwear and clothing .The forecast of the changing Consumer Price Index during the period of economy downturn will help BSA guns to vary the price of their product for short term so as to match the expected target . BSA guns exports its 557 products to different countries which implies that the application of concepts of own price and income elasticity demand for different countries will help BSA to skim the initial revenues because if the

economy is low in UK it can gain the consumer surplus from other countries where the economy is booming and hence cover the fixed costs and variable costs .The arbitrage concept can be applied here which will allow BSA guns to produce units in one market and sell the product in another market and can generate revenue untill one price is agreed on to its products which is law of one price and this agreed price should fall under the range of best price set by the company for different products with reference to proper study of income distribution and responsiveness of demand for the products.

According to a research made in European journal of scientific research , the application of the concept of own price elasticity demand and income price elasticity demand on the cellular services in UK ,with respect to fixed landlines and mobiles , lead to the conclusion that for every 1 % increase in price of their services the demand will decrease by 0.53% on average .The usage of mobile telephone was found to be positively related to the GDP of UK which means that the income price elasticity of demand is also a key deciding factor for price setting which varies with the changing economy . The case study that was carried out in USA for Spaghetii sauces in order to determine the variation in quantity demanded in different regions with change in price of the product and the change in income of the consumers brought in light the importance of the concepts of own price elasticity and income elasticity demand .The differences and the similarities between the price elasticity and income elasticity were carried out for different regions and under different markets .The result to the research pointed out that the six major spaghetti sauce brands demand vary significantly in different regions with slight changes in the best price set. By understanding the price elasticity concept the manufacturers of these brands are now in a position to plan and implement appropriate pricing and promotional strategies which increase the revenue of the company. In Conclusion, the elasticity of demand for BSA guns products vary substantially across different income groups.Therefore, it is very important to estimate the gun demand elasticity specific to income groups. The increase in population and an increase in per caita income will increase the demand of guns and their related accessories .The estimated income elasticity of demand tends to be higher in poor households as compared to affluent members of the society. The income

distribution of these members varies with changing economy and income elasticity of demand again tends to be high in case of economy downfall . The know how of the economic concepts of price elasticity and income elasticity of demand becomes mandatory because of the dependence of sales on the income distribution . The results of the worthful endeavour of analysis of income distribution and decisions dealing with setting a best price are crucial for the future modeling and analysis of the airgun sector in UK. Dissaggregated price and income elasticity will be helpful for policy planners who are interested in future investment and development of the company.

REFERENCES

Umar Farooq.S , Imran Ullah . M , Rahamani .R . (2010) The Analysis of Cellular Services and Estimating Fixed to Mobile Price Elasticities -A Case Study of United Kingdom European Journal of Scientific Research 40 (3) 428-440. Seo .S.c , Capps .O.Jr. (1997) Regional Variability of Price and Expenditure Elasticities: The Case of Spaghetti Sauces Agribusiness 13(6) 659-672.