Buyer price sensitivity: Escort vis-à-vis Civic

Ford and Honda cater to the subcompact segment of the automobile market with their Escort and Civic models, respectively. Are Ford Escort buyers more or less price sensitive than buyers of Honda Civics? One way to answer this question is to estimate the change in quantity demanded from a $100 increase in the price of each make. But this does not compare like with like.

A consistent way of comparing the price sensitivity of Escort and Civic buyers is to use the own-price elasticities of the demands. The own-price elasticities of the demands for Escorts and Civics have been estimated to be both 3.4. This indicates that Escort and Civic buyers are equally sensitive to price. For a 1% increase in price, both groups would reduce purchases by 3.4%.

Source: Pinelopi Koujianou-Goldberg, “Product Differentiation and Oligopoly in International Markets: the Case of the U.S. Automobile Industry,” Econometrica 63, no. 4 (July 1995), pp. 891-951.

Pricing breakfast cereals

Eugene Jones and Barry W. Mustiful of Ohio State University studied the demand for breakfast cereals at six outlets of a national supermarket chain in the Columbus, Ohio, metropolitan area. They found that the demand was inelastic with respect to price: The own-price elasticity of demand for the top 10 brands was 0.7, while the elasticity for private label cereal was 0.6.

We have shown that, where demand is price inelastic, a seller can increase profits by raising price. The supermarket chain could have increased its profits by raising the prices of both branded and private label breakfast cereals at its Columbus area stores.

Source: Eugene Jones and Barry W. Mustiful, “Purchasing Behaviour of Higher- and Lower-Income Shoppers: a Look at Breakfast Cereals,” Applied Economics 28, no. 1 (January 1996), pp. 131-7.

Breaking even

In April 2000, Dow Jones re-launched the Asian Wall Street Journal with substantial price cuts in four major markets. In Hong Kong, where the paper had a daily circulation of 12,800, the cover price was reduced by 40% from HK$15 to HK$9, while the subscription price was reduced by 10% from HK$2,550 to HK$2,298. Management kept advertising rates unchanged at $17 per agate line and $30,192 for a full-page black-and-white advertisement. What must be the own-price elasticity of demand for the re-launch to break even just in terms of revenue?

Suppose that the proportion of regular subscriptions in daily circulation was 86%, which was the proportion for the main Wall Street Journal. Then, the Asian Wall Street Journal’s circulation in Hong Kong would have consisted of 11,000 regular subscribers and 1,800 single-copy sales. Advertising revenue would depend on the newspaper’s circulation. We assume that annual advertising revenue was $499 (or HK$3,860) per copy.

Before the re-launch, the annual circulation revenue from subscriptions would have been HK$2,550 x 11,000  HK$28 million. The advertising revenue from copies sold by subscriptions would have been HK$3,860 x 11,000  HK$42.5 million a year. Total circulation and advertising revenue from subscribers was HK$70.5 million.

The re-launch reduced the subscription price by 10% to HK$2,298. Suppose that the price cut raised subscription volume to S thousands. Then the re-launch would break even in terms of circulation and advertising revenue from subscribers if 70.5  2.298 x S  3.86 x S, or S  11.45. For the re-launch to break even in terms of all revenues from Hong Kong subscribers, the volume of subscriptions must rise to at least 11,450, which is a 4.1% increase. Since the price was reduced by just 10%, this means that the required own-price elasticity was 0.41 or lower.

Before the re-launch, the annual circulation revenue from single-copy (newsstand) sales would have been HK$15 x 250 x 1,800  HK$6.8 million, assuming 250 publication days a year. The advertising revenue from single-copy sales would have been HK$3,860 x 1,800  HK$6.9 million a year.

The re-launch cut the cover price of the newspaper by 40% to HK$9. In a similar way as for the subscription sales, we can show that, for the re-launch to break even in terms of all revenues from Hong Kong single-copy buyers, the volume of sales must rise to at least 2,242. This implies that the own-price elasticity must be 0.61 or lower.

In practice, Dow Jones should also consider the additional costs arising from the re-launch, and then assess the impact of the re-launch on profit. Further, it need not necessarily break even in each of the customer segments - subscribers and single-copy buyers - separately. All that it should consider is the overall profit.

Sources: “Publisher’s Statement: Asian Wall Street Journal,” (http://www.media.com.hk/kits/505.htm/); Dow Jones & Co. Inc., Form 10-K for 1999; and letter dated July 18, 2000, from Urban C. Lehner, publisher of the Asian Wall Street Journal.

Price Elasticity for Cigarettes

U.S. has increased taxes on cigarettes dramatically in the past 5 years. A majority of adult smokers have sucked it up and continued smoking. Dr. Thomas R. Frieden, the commissioner of the city Department of Health and Mental Hygiene in New York has conducted several surveys among young adult and teen smokers. City and state tobacco taxes, which have been gradually rising in recent years and now add $3 to the price of each pack of cigarettes, for a total of $5.50 or more. “Kids are most susceptible to price because they don’t have a whole lot of disposable income,” Dr. Frieden said. “So when you increase the price of cigarettes, you drive smoking down generally among adults but especially for teens.” Raising the taxes will have a much more noticeable effect short term users. The older (faithful users) they are less sensitive to price changes.

Source: A. RAMIREZ, New York Times, Published: January 3, 2008 Teenagers in the City Smoke Less, Report Finds

Increasing the Gas Tax

In a 1996 article in the Energy Journal, authors Jonathan Haughton and Soumodip Sarkar attempt to answer the question of what impact a $1 gasoline tax increase would have on driving and accidents. They submit that with a gas tax of $1, miles driven would decrease by up to 12% and fatalities by up to 18%.

How do they get to these results? By estimating and using the own-price elasticity of gasoline to calculate the impact on gasoline consumption.

The retail price of gasoline in 1991 was $1.13, of which 28% or $0.32 was tax. Assuming that the entire tax increase is applied to the price, this means a price increase of $0.68, or 46%. The long run own-price elasticity of demand for gasoline over a ten-year period was calculated to be in the range -0.23 to -0.35. Using this knowledge we can calculate the change in consumption:

%ΔQ/46% = -0.23

%ΔQ = -0.23 * 46% = -10.6%

%ΔQ/46% = -0.35

%ΔQ = -0.35 * 46% = -16.1%

Without going into the effect on accidents, we can still determine that a gas tax of $1 would decrease gas consumption by between 10.6% and 16.1%.

Source:

Haughton, J. & Sarkar, S. (1996) Gasoline Tax as a Corrective Tax: Estimates for the United States, 1970-1991, Energy Journal vol 17 no 2 p103-26.

Price Elasticity and Art

The premise behind highly elastic goods is that people's buying habits will change based on the price of a good—price it lower and people will buy more, price it higher and people will buy less.

I wanted to explore the relationship between artistic goods and this sensitivity. It appears that goods that are considered commodities (mass produced and often unspecialized products with many substitutes) are subject to higher price elasticity, while items that are considered collectible are often subject to much lower price elasticity.

A mass produced bronze statue sold on the streets of Athens has a relatively higher price elasticity of demand, whereas fine art has relatively lower price elasticity--the number of buyers of Picasso stay pretty much the same if the price doubles.

That being said, how do artist allow their work to move from being a commodity to a collectible? The opposite combination of qualities found in commodities may inform this discussion. Art work which is not mass produced but rather created with a high level of craftsmanship and mastery of skill is likely to be more inelastic.

Many works of art see a great increase in value, demand and inexlasticity after the artist dies, so scarcity appears to affect price elasticity. Artists will often produce limited-runs or signed collections in order to reproduce this scarcity (prior to their death) and make their goods more inelastic and less prices sensitive. More famous artist often can command a greater price and have greater price inelasticity than lesser known artists because scarcity exists because there is a limited number of works an artist can create in a lifetime.

The research paper “The Demand for Art: Resolving the Conflict between the Consumer and the Connoisseur” explore the quality of art and its inelasticity:

David Throsby (1994) of Macquarie University did a study on the elasticity of the demand for the performing arts, among which art exhibitions are considered. He found consumer demand for tickets to such events to be strongly inelastic. When ticket prices went up, people kept buying at about the same amount.

It turned out that ticket sales were strongly influenced by changes in quality. If people felt that the quality of an exhibit had gone down, their purchases went down significantly. In other words, consumers were quality elastic, but price inelastic. What does this mean about art sales? It might mean nothing at all. But what it does begin to show is that consumers are much more concerned about the quality of art than they are the price of art. So art lovers need not worry about the negative correlation between quantity and price of art. It doesn’t mean that people are demanding lower quality art because they demand a little more art at lower prices. In fact, in this example if art quality was to go down, people would actually demand less of it. A lower price of art doesn’t necessarily correlate to lower quality (p. 13).

Inspired from postings at http://photo.net/bboard/q-and-a-fetch-msg?msg_id=00AF4D

Quote from the research paper “The Demand for Art: Resolving the Conflict between the Consumer and the Connoisseur”, Retrieved February 23, 2008 from http://economics.gcsu.edu/papers/student1.pdf

How elasticity affects the market for illegal goods

Suzanne Wu

13.01.2006

In an important new study, world-renowned economists--including a Nobel Prize winner and a MacArthur "genius"--argue that when demand for a good is inelastic, the cost of making consumption illegal exceeds the gain. Their forthcoming paper in the Journal of Political Economy is a definitive explanation of the economics of illegal goods and a thoughtful explication of the costs of enforcement.

The authors demonstrate how the elasticity of demand is crucial to understanding the effects of punishment on suppliers. Enforcement raises costs for suppliers, who must respond to the risk of imprisonment and other punishments. This cost is passed on to the consumer, which induces lower consumption when demand is relatively elastic. However, in the case of illegal goods like drugs--where demand seems inelastic--higher prices lead not to less use, but to an increase in total spending. 

In the case of drugs, then, the authors argue that excise taxes and persuasive techniques –such as advertising--are far more effective uses of enforcement expenditures. "This analysis…helps us understand why the War on Drugs has been so difficult to win…why efforts to reduce the supply of drugs leads to violence and greater power to street gangs and drug cartels," conclude the authors. "The answer lies in the basic theory of enforcement developed in this paper."