The quantity of products sold and the profit-margin is dictated by the price level of the product. Before deciding on a product price a business must take a number of considerations into account:

– Business objectives: if the objective of the company is to maximise its profits then the price will be high.

– Industry competition: the number of competitors will affect the product price.

– Distribution channels: a selling price will increase with the number of intermediaries required to get the product from the factory to the consumers.

– Business image: a more up-market business can charge a higher price for its products.

A business can use number of strategies to calculate the best product selling price:

• Cost-plus pricing: a percentage profit is added on to the cost of producing the product.
• Mark-up pricing: a profit mark-up is added to the direct cost of each unit. The mark-up profit needs to cover any fixed overheads and then be able to contribute towards the profit.
• Predatory pricing: also known as destroyer pricing, this is where a company sets its prices so low that smaller companies can’t compete and so are forced to leave the market. Larger businesses are then left to dominate and have the freedom to increase their prices in order to regain any losses.
• Skimming pricing: this is where a new product is given an up-market image by making its price very high. Innovative or high-tech products tend to use this strategy on products that carry high production costs.
• Penetration pricing: this is used by businesses that want to undercut their competitors and put off potential rivals. The product is launched at a low price to build up its market share rapidly and its brand loyalty. At a later date the company can then rise the product’s price.
• Demand-orientated pricing: the price is set according to how the customer’s perceived the product.
• Competition-orientated pricing: both production costs and customer demand is ignored and the price level is based on the pricing of the company’s competition. It could be to undercut, charge higher, or even charge the same. The term used to describe a company which charges the a similar price for a similar product is known as ‘going rate pricing’.

Elasticity Concept

The concept is how the demand changes if one factor that influences the demand of a product is changed. For example, the product price or the product’s advertisement.

Price elasticity of demand

This looks at whether the demand changes if the price of the product changes.

Inelastic demand: products which have an inelastic demand curve are fast-moving goods, like bread and soap, and habit-forming goods, like tobacco and alcohol. As you can see from the diagram below, the percentage change in quantity demanded is much less than the percentage change in the price that brought it about.

Elastic demand: products with an elastic demand are luxury goods, like cars and televisions. The percentage change in quantity demanded is larger than the percentage change in the price that brought it about.

Perfectly inelastic demand: This is where the demand doesn’t respond to any change in price.

Perfectly elastic demand: This is where there’s only demand for a certain price. In other words, at any other price there’s no demand.

For both perfectly inelastic demand and perfectly elastic demand there are no examples because these are theoretical extremes.

Price elasticity can be calculated using the following formula:

– If the answer is zero then this is an indication that the demand for the product is perfectly inelastic.

– If the answer lies between zero and one then this indicates that the demand for the product is inelastic.

– If the answer is one then this indicates that the demand for the product is unitary elastic.

– If the answer is greater than one but less than infinity then this indicates that the demand for the product is elastic.

– If the answer is infinity than this indicated that the demand for the product is perfectly elastic.

Income elasticity of demand

This is how demand changes in respect to changes in the incomes of the consumers.

• If an increase in income causes an increase in product demand then the product is considered normal.
• If an income in income leads to a fall in demand then the product is regarded an inferior.

The formula for calculating income elasticity of demand is:

– If the answer’s positive then this indicates that the product’s normal. A high positive figure would indicate that it’s a luxury product.

– If the answer’s negative then this indicates that the product’s inferior. The larger the negative value is the more inferior it is.

– If the answer’s zero then this indicates that the changes in income don’t have an effect on the demand of the product. In other words, the product is completely income elastic.

Advertising elasticity of demand

This is how demand changes in response to a change in the advertising expenditure which is used to promote it.

The formula for calculating advertising elasticity of demand is:

– A positive answer indicates that the advertising campaign is successful as increasing expenditure increases demand or decreasing expenditure decreases demand.

– A negative answer indicates that the advertising campaign isn’t successful as increasing expenditure causes a fall in demand and decreasing expenditure leads to a rise in demand.