NOTES ON PRODUCT PRICING

By Dr Ponnam Abhilash: abhilashponnam@gmail.com

Concept 1: Price Elasticity of Demand

Formulating the regression model:
Y = quantity purchased
X = price of the product

lnY = b0 + b1*(lnX) + b2*t+ e //controlling for the effects of time by using t

d/dx [lnY] = b1* d/dx [lnX]
dY/dx [1/Y] = b1*[1/X]
b1 = dY/dx [X/Y] =[dY/Y]/[dX/X]

Finding the price elasticity of demand

b1 = percentage change in sales quantity for one percent increase in price
b1 = price elasticity of demand

Applications of price elasticity of demand:

1. To find optimum pricing strategy
Optimal Price = [ b1/(1+b1)] * variable cost per unit
By getting the lower bound and upper bound for b1, we can get optimal price interval

2. Finding about price sensitivity

When b1 < -1, demand is elastic. This can be interpreted as consumers being very sensitive to
changes in price: a 1% increase in price will lead to a drop in quantity demanded of more
than 1%.

When -1 < b1 < 0, demand is inelastic. This can be interpreted as consumers being insensitive
to changes in price: a 1% increase in price will lead to a drop in quantity demanded of less
than 1%.
When b1 = -1, demand is inelastic. This can be interpreted as consumers being insensitive to
changes in price: a 1% increase in price will lead to a drop in quantity demanded will be
equal to 1%.

When b1 is equal to 0, demand is perfectly inelastic. This can be interpreted as consumers

being extremely insensitive to changes in price: a 1% increase in price will not lead to any
change in demand

When b1 is > 0, demand is positively elastic. This can be interpreted as follows: increase in
price leads to increase in demand instead of decrease in demand. This holds true for luxury
goods.

Factors effecting price elasticity:

Availability of competitive products offering similar benefits at lower price: b1 < -1

Non availability of competitive product offering similar benefits: -1 < b1 < = 0

Availability / Accessibility of information about competitive products => b1 < -1

Availability of no alternative b1 =0

For Luxury brands: b1 > 0

Managerial applications of price elasticity:

When -1 < b1 < 0, increase in price will improve the revenue

When b1 < -1, increase in price will decrease the revenue

Optimal Pricing Guide

CP = Cost Price / Variable Cost per Unit

SP = Selling Price

Margin = (SP – CP)/SP

OPG = (1/margin) - |elasticity|

Optimal SP is when OPG = 0.

Managerial application of OPG

OPG > 0, increase selling price to improve profits

OPG < 0, decrease selling price to improve profits

Concept 2: Pricing Models:

 Van Westendorp’s price sensitivity meter 

Method:

Ask your customers a series of four questions:

1. At what price would you begin to think the good/service is so inexpensive that you
would question the quality and not consider it?

2. At what price would you think the good/service is a bargain — a great buy for the

money?

3. At what price would you begin to think the good/service is getting expensive, but you
still might consider it?

4. At what price would you begin to think the good/service is too expensive to consider?
YELLOW CIRCLE: Point of marginal cheapness: At this point, the number of participants
who view the product as being too cheap is equal to the number of persons who view it as not
too cheap

BLUE CIRCLE: The Indifference Pricing Point (also called the Perceived Normal Price) is

the point at which the number of persons who view the product as being good value is equal
to the number of persons who view it as being expensive.

ASH CIRCLE: The price point at which the number of potential customers who view the
product as either too expensive or too cheap is at a minimum is known as the Optimal Pricing
Point (or the Penetration Price). Here, the number of persons who would possibly consider
purchasing the product is at a maximum.

GREEN CIRCLE: Point of marginal expensiveness [highest reasonable price]: At this point,
the number of participants who view the product as being too expensive is equal to the
number of persons who view it as not being expensive.

Managerial Implications:

Price between Yellow and Green Circle. Model Preferable pricing point is Ash Circle.

Limitations: Van Westendorp questions provide no information about willingness to purchase

Extending VW Model:

Ask the customers what is the realistic price that they are willing to pay if they need to
purchase the product?

Before starting of the questionnaire, ask the customer what is their probability of purchasing
the product? Only consider the responses whose probability of purchase is greater than .
75. This reduces the contamination in the model