Elasticity of demand refers to measurement of variability in quantity demanded in response to change in the price of product or services. In economical term, elastic demand is arises when the price, income or other factors affect the purchasing behaviour of customer. As the price of a commodity has an inverse relation with the demand of that product according to 'the law of demand'. This assignment is based of TESCO, a British multinational groceries and general merchandise retailer (Buer, 2016). It deals in various product categories such as food, grocery items, clothing, furniture, financial services and many more throughout the world. This report contains an explanation about the elasticity of demand and different elements of elasticity. Further it also describes about the importance of elasticity of demand in decision making process of TESCO and its practical application of this concept.
Elements of elasticity
In economics, elasticity refers to measuring the reaction of demand and supply due to change in price or income level. This elasticity varies from product to product which depend upon the need and requirement of consumers (Chandra, Gruber and McKnight, 2014). Commodities that are consider as necessities of consumers, tend to be less sensitive to changing price as end users keep on buying these products despite of price increment. Following formula is used for evaluating the elasticity of demand or supply of a commodity.
Elasticity = (%change in quantity/ %change in price)
When elasticity is greater than or equal to 1, curve is consider as elastic. But in case it is less than one, curve is consider as inelastic.
Source: Types of Elasticity of Demand, 2018
Above given image shows the various types of factor in elasticity of demand which have an direct impact over the demand or supply of goods or services. Elements of elasticity are of three types, which are as follows:
- Price elasticity of demand:-It refers to the degree of responsiveness of demand due to change in price of a product or services. Price elasticity of demand represent the relationship between quantity demanded and price of commodity as well as shows the effect of this change (Price Elasticity of Demand, 2016). There are various factors which affect the price elasticity of demand such as availability of close substitute product, income spent over commodity, cost of switching, brand loyalty etc. Price elasticity of demand is calculated as:
Ep = (Δq/Δp) (p/q)
Where, p refers to the price and q refers to quantity of goods demanded. This formula generally provides negative value due to inverse relationship between price and quantity as per “the law of demand” (Esteves, and Reggiani, 2014). From the above formula it is interpreted that, if
- percent change in demanded quantity is greater than percent change in price then, price elasticity will be greater than one and demand is said to be elastic.
- When percent change in quantity demanded is less than change in price then, price elasticity will be less than one and demand is called as inelastic.
- When percent change in price is equal to quantity demanded than elasticity will be equal to one and demand is said to be unit elastic.
- Cross price elasticity of demand:- Cross price elasticity refers to the measurement of percent change in the quantity demanded of one good due to change in the price of another product. Consumption behaviour of customers affects the cross price elasticity as change in the price of related goods affects the demand of another goods. Related goods are of two types i.e. substitute and complementary goods (Cross Price Elasticity of Demand, 2018). The cross elasticity for substitute product is always positive as with the increase in price of one good the demand for substitute product increases. On the other hand cross elasticity for complementary commodities is negative as when the price of one item increases the demand of product closely associate with that item decreases. Following formula is used to evaluate the cross price elasticity of demand:
Exy = % change in quantity demanded of X/ % change in price of Y
Where, X & Y denote the two commodities and Exy shows the relationship between these two commodities.
- Income elasticity of demand:- It refers to the measurement of degree to which quantity demanded of a product decreases with the change in the income of consumers. Income level of customer is consider as an important determinant in product elasticity as demand for a commodity has a direct relationship with consumer's income (Income Elasticity of Demand, 2018). In term of income elasticity product are divided into two categories such as inferior goods and normal goods.
Normal goods always have positive income elasticity of demand, as with the increase in consumer's income the demand for more goods arises at each price level. These goods are generally comes under necessity product category which a consumer buy despite of change in income level (Danzon, Towse and MestreFerrandiz, 2015). On the other hand inferior goods have negative income elasticity of demand, because with the increase in consumer's income the demand for inferior goods decreases as customers may switch to luxury products. Following formula help in evaluating the income elasticity of demand:
Ey = % change in quantity demanded / % change in income
Where, Ey refers to elasticity of demand and consumer's income has a direct relation with the demand of product.
Impact of elasticity over business decision making
Elasticity is defined as the degree to which a consumer, producer or individual changes their demand or amount of supply with the changes in the price or income level. Elasticity of demand plays an essential role in decision making process of various companies such as TESCO, Walmart etc. As they operates in dynamic environment where demand of customers changes rapidly (Krishnamurthy and Kriström, 2015). Therefore, it is very essential for TESCO to evaluate the elasticity of demand while formulating various marketing strategies regarding the price of product. Impact of elasticity of demand over TESCO can be better understood using following points:
Price elasticity of demand:- It refers to the measurement of responsiveness in demand of product with the change in the price of commodity. Price elasticity concept explains that the demand of a commodity has an inverse relation with its price. As demand of the product increases with the decrease in price of that commodity and vice-versa. For instance, TESCO offers low price product or services in order to increase the demand of their target market.
Price elasticity of demand has an huge impact over the price related decision making of TESCO. As the demand of customer for a product or services are directly affected by the cost of that commodity. So it is very essential for TESCO to identify various factors such as buying behaviour, value of product to customer and their willing to pay for that product before setting up the price of product (Miller and Alberini, 2016). Like for its grocery product range, TESCO must keep price relatively low as these product have elastic demand and also number of competitors are present in the market which offers same range of product. Therefore, in order to survive in market and increase the demand for product, company is required to keep its price of grocery items at minimum.
On the other hand product range which have inelastic demand such as financial services, TESCO can keep its charges higher (Leamer and Stern, 2017). As these services are not price sensitive and customer's get ready to purchase it at any price if they are getting better return over their investment. Hence, the price elasticity of demand is very essential for TESCO in its price determination decisions.
Cross price elasticity of demand:- This concept of cross price elasticity help in identifying the percent change in demand of a product due to change in price of another product. Cross price elasticity shows the relation between two commodities which are interrelated and both have inverse relationship as change in price of one commodity affect the another. For example, demand of TESCO's product get highly affected by the price of other discount supermarkets. As with the increase in price of product offered by TESCO, customer have an option to switch toward another discount store such as ALDI.
Cross price elasticity is very essential factor to be consider in decision making process as it help TESCO in deciding the price of product which is adoptable by target market and help in increasing the demand of product within market (Mohajeryami and et. al., 2016). This concept generally includes two categories which are as follows:
- Substitution :- It refers to the method or action taken to replacing one entity with another which offer same benefits. Cross price elasticity is an very essential factor for TESCO which is to be consider while formulating strategies and deciding the price of its products. As TESCO is required to set its price of product according to the purchasing behaviour and spending power of the customer that belongs to society in which company operates. This help in increasing the demand of their product and achieving competitive advantage in market place. It also help in minimizing the brand switching as there are number of substitute present in market such as ASDA, ALDI etc., which offer products at affordable prices.
- Complementary sources:-It refers to the combination of two entities in such a way that enhance the quality of one another. Complementary sources in term of TESCO are the supplier which deliver commodities or raw material to company. It is very essential for TESCO to consider the bargaining power of supplier before setting up the price of their product or services. As increase in the price charged by its supplier direct increases the prices of products offered by company which in turn will decrease the price of the product (Safdarian, Fotuhi-Firuzabad and Lehtonen, 2014). Therefore, it is very essential for TESCO to maintaining high network of supplier so that they can switch them in order to get raw material at relatively low price and can keep their cost at minimum. This help them in offering product at affordable price which further maximize the demand of commodities.
Income elasticity of demand:- It refers to the change in the demand of product or service due to change in the income level of targeted market. The concept of income elasticity shows the impact of change in consumer's income over the demand of commodity. As consumers with lower income prefer to purchase from stores which offer product at lower price and under the budget of customer. On the other hand, when the income level of customer increases the demand for superior product increases and lower price commodity decreases. For instance, TESCO offers the products that are daily necessities of customers and which they purchase despite of any price change.
Income level of customers also affect the elasticity of demand and price determination decision of a company. As TESCO operates in different countries throughout the world, therefore it is very important for company to evaluate the income level of target market. This help in deciding the price of commodity according to the spending power of customer so that company can maintain demand of its product demand despite of geographical location (Valin and et. al., 2014). As people at different location are different in term of their purchasing behaviour and income level. So TESCO must offer its product or service at discriminate price in different location according to the elasticity of demand for its commodity. For instance, TESCO must offer its commodity at lower price in market which have elasticity in demand and at high price to the market which is less elasticity in demand.
From the above given report it can be summarized that the price of a commodity have an inverse relationship with the demand of that product in marketplace. Therefore the concept of elasticity of demand plays an essential role in decision making process of company for offering its product or services. Application of this concept in decisive practices help an organisation in determining and setting the price of their commodity according to the buying behaviour and spending habit of their target market. This further help in increasing the demand of commodity in market place.
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