Pricing

Pricing

Quality price relationship: In absence of proper/quantifiable quality benchmarks, consumers infer quality of products through price.

Price Demand relationship: For most goods as price increases, demand increases. But for conspicuous consumption or luxury goods, price and demand are inversely related. For luxury goods, as price increases, demand increases. But at some point, the downward slope of demand kicks in.

Own Price elasticity is the percentage change in sales volume of a product per percentage change in price. The formula (dQ/dP)(P/Q) is used because it becomes a unit less quantity and so is easier to compare. When the percentage change in demand is higher than the percentage change in price, the product is said to be elastic. Products with many substitutes are usually elastic (eg: commodities).  When the percentage change in demand is lower than the percentage change in price, the product is said to be inelastic. Products with fewer substitutes are usually inelastic (eg: gemstones). When the percentage change in demand is equal to the percentage change in price, the product is said to be unit elastic. Elasticity of the same product will be different across different countries, markets, areas (urban vs rural) and even when the product is packaged differently (bottled coke vs coke can). Some products may be inelastic in the short run but may be elastic in the long run (eg: cigarette, gasoline, etc). So, we need to take actions accordingly. For example, while setting process of SKUs in a retail setting, we need to look into short run elasticity.[pic 1][pic 2]

There are 2 pieces of information required before making any decision regarding increasing or decreasing the prices:

1. Marginal Cost
2. Price sensitivity (elasticity)

When the demand is inelastic (|E|<1), price and revenue move in the same direction, so does profit. So if price increases for an inelastic product, the revenue and profit will increase. But for elastic demand (|E|> 1) price and revenue move in the opposite directions. So, if price increases for an elastic product, the revenue will decrease and we can say anything about profit, whether it will increase or decrease without having the information of marginal cost.