MKTG 4110 Class 11

PRICE ELASTICITY\

 Elasticity measures the price-quantity relationship at a specific point

o (i.e., shape of the demand curve)
 Elasticity is a unitless measure: invariant to currency (e.g., dollars, yen),
 invariant to unit metric (e.g., pounds, boxes)

 Price Elasticity Interpretations?

 If price increases (decreases) by 1%, quantity decreases (increases) by PE%

 We use price elasticity as a measure to

quantify how consumers respond to a price
change

Substitutability
 highly elastic products are highly
substitutable
 A small price increase causes consumers to
choose another option
 A small price decrease causes consumers to
buy more
When Does Price Elasticity Make Sense

What are typical price elasticities?

 Promoted Price: -1.5 to -4 is “normal” (always negative)

 Regular Price: -1.1 to -2.5 is “normal” (smaller than promo)

What if elasticity is < -4 (e.g., -5, -6, etc.)?

 Very elastic (price sensitive) -> Extremely competitive market, commodity

What if elasticity is > -1.1 (e.g., -0.9, -1, etc.)?

 Very inelastic (price insensitive) -> Few competitors, unique product

Brand with Large Market Share

At higher levels of
aggregation/mk share,

demand becomes more

inelastic as there are
fewer substitutes

Brand with Small Market Share

Optimal Price

Assume we measured a PE as -2.67

Marginal cost of your item is $1.18
Then, optimal price should be: $1.18*(-2.67 / (-2.67 + 1)) = $1.89
Log-log demand model

Applying a Natural Log

 Think of applying a natural log as transformation of numbers;
 you can shrink it and always go back!

 In the log-log demand model, we assume the effects are multiplicate not additive

Additive Demand (Price and Quantity) Model Multiplicative Demand (Price and Quantity) Model

Quantity = a + b*Price + e Quantity = a*(Price ^b)*v

by taking log (or natural log ln) of both sides, we have

ln(Quantity) = ln(a)+ b*ln(Price) + e

We can use this log-log model as a regression
Why use log-log demand model?

 We want our regression model to fit the data better!

 We want results that are easy to interpret
2. Adding Control Variables (Going From Bad to Good Analytics)

 Our Clif manager is worried that price elasticity might not be accurately estimated
 potential confounding factors and adding control vars
o Yearly trends
o Merchandising (Sales) of Cli

ln(Quantity) = b0+ b1*ln(Price) + b2*Sale + b3*Y13Dum + b4*Y14Dum

 Price elasticity works as a guideline for pricing

Opt. Price = Marg. Cost ∗ PE/(1+ PE)

 PE = -2.67
 Cost of Clif bar = $1.18
Optimal price: P = $1.18 * (-2.67 / (-2.67 + 1)) =$1.89

 What if we didn’t correct the PE?

P = $1.18 * (-4 / (-4 + 1)) =$1.57
 This is significant based on the p value as it is less than 0.05
 (3) If Clif bar conducts a sale (merchandising) on a given week, what is its impact
on unit sales of Clif on average? Show your calculations. Feel free to use a
scientific calculator
 * EXPONTENIATE: specifically, the sale_cliff

 Ln(Quantity) = ... 0.32*SalesDummy ...

 Exp(Ln(Quantity)) = Exp(0.32*SalesDummy)
 Quantity = Exp(0.32)^SalesDummy

(a) Quantity When Sales Dummy = 0 -> Exp(0.32)^0 = 1

(b) (b) Quantity When Sales Dummy = 1 -> Exp(0.32)^1 = Exp(0.32)

Divide (b)/(a) = Exp(0.32)/1 = Exp(0.32) = 1.37

(b) = 1.37*(a) -> When on Sales, You Sell 1.37 times more (or 37% increase)

 This is not significant based on the p value as it is larger than 0.05

 REMEMEMBER Pr(>|t|) IS THE P VALUE