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USC / Marketing / MKTG 351 / What is the key formula you should use in price elasticity of demand?

# What is the key formula you should use in price elasticity of demand? Description

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Price Elasticity of Demand

## What is the key formula you should use in price elasticity of demand?

This is the key formula you should use: E = (∆Q/ Q) / (∆P/ P)

where:

E = Price elasticity of demand

∆Q = Change in quantity (New quantity – Old quantity)

Q = Old quantity

∆P = Change in price (New price – Old price)

P = Old price

Practice Questions:

Your firm sells product Gamma. The own price elasticity of Gamma is -0.5.  The price of Gamma is \$20 and the quantity sold of Gamma is 100. Suppose  the price of Gamma is raised to \$30. What is the new quantity sold of  Gamma?

25, 75 or 125?

Here:

E = -0.5

∆Q = X (to be determined)

Q = 100

∆P = \$10 (i.e. \$30-\$20)

## Your firm sells product theta. the own price elasticity of theta is -2. the price of theta is \$20 and the quantity sold of theta is 100. suppose your boss tells you to increase sales of theta to 150, by changing price of theta. what should you set the new price of theta?

Don't forget about the age old question of What is the definition of market segment?

P = \$20

OR -0.5 = (X/100) / (10/20)

OR X = -25

∆Q = -25

OR (New quantity – Old quantity) = -25

OR (New quantity – 100) = -25 We also discuss several other topics like What is the study of matter?

OR New quantity = 75

If the price of Gamma is raised to \$30, the new quantity sold of Gamma is  75.

Your firm sells product Theta. The own price elasticity of Theta is -2. The  price of Theta is \$20 and the quantity sold of Theta is 100. Suppose your  boss tells you to increase sales of Theta to 150, by changing price of Theta.  What should you set the new price of Theta?

## How to approach topics in behavioral economics?

Here:

E = -2

∆Q = 50 (i.e.150-100)

Q = 100

∆P = X (to be determined)

P = \$20

OR -2 = (50/100) / (X/20)

OR X = -5 (solve for yourself)

∆P = -5

OR (New price – Old price) = -5

OR (New price – 20) = -5

OR New price = 15 (solve for yourself) Don't forget about the age old question of Define operant conditioning.

If you wish to sell 150 units of Theta, you should set the price of Theta to   \$15.

In these examples Theta demand is elastic:

Theta price change -25% (from \$20 to \$15)

Theta quantity change +50% (from 100 to 150)

‘Q’ | 50% | > ‘P’ |-25% |

‘Q’/’P’ = -2.0

Gamma price change +50% (from \$20 to \$30)

Gamma quantity change -25% (from 100 to 75)

‘P’ | 50% | > ‘Q’ |-25% |

‘Q’/’P’ = -0.5 If you want to learn more check out What are the different types of volcanoes and their connection to tectonic environment?

Your firm sells product Theta. The own price elasticity of Theta is -2. The  cross price elasticity of Theta wrt price of Gamma is +2. The price of Theta is \$20 and the quantity sold of Theta is 100; current price of Gamma is \$100.  Suppose your boss tells you to increase sales of Theta to 150, not by  changing price of Theta, but by changing price of Gamma. What should you  set the new price of Gamma?

Here:

E = +2

∆Q = 50 (i.e.150-100)

Q = 100

∆P = X (to be determined)

P = \$100

OR +2 = (50/100) / (X/100)

OR X = +25

∆P = +25

OR (New price – Old price) = +25

OR (New price – 100) = +25

OR New price = 125

If you wish to sell 150 units of Theta, you should set the price of Gamma to  \$125.

Your firm sells product Theta. The own price elasticity of Theta is -2. The  cross price elasticity of Theta price of Alpha is -2. The price of Theta is \$20  and the quantity sold of Theta is 100; current price of Alpha is \$100.  Suppose your boss tells you to increase sales of Theta to 150, not by  changing price of Theta, but by changing price of Alpha. What should you set the new price of Alpha? If you want to learn more check out What is the first known written law codes in history?

Here:

E = -2

∆Q = 50 (i.e.150-100)

Q = 100

∆P = X (to be determined)

P = \$100

OR -2 = (50/100) / (X/100)

OR X = -25

∆P = -25

OR (New price – Old price) = -25

OR (New price – 100) = -25

OR New price = 75

If you wish to sell 150 units of Theta, you should set the price of Alpha to  \$75

In this example, Gamma is a substitute and Alpha is a complement

Gamma price change +25% (from \$100 to \$125)

Gamma quantity change -ve

Theta quantity change +50% (from 100 to 150)

‘G’/’T’ = +ve (typo?) SUBSTITUTE

Alpha price change -25% (from \$100 to \$75)

Alpha quantity change +ve

Theta quantity change +50% (from 100 to 150)

‘A’/’T’ = -ve (TYPO) COMPLEMENT

Behavioral Economics

How to approach topics in Behavioral Economics:

- Economics would predict “X”

- But what happens “out in the world” is “Y” and not “X”  - Here are how firms can use the above information to improve their 4  P’s

Human behavior is not consistent with the strict axioms of rationality as  posited by economists

Economists think:  If you want to learn more check out Spanish built more than how many catholic churches?

Consumers receive product information Consumers consider utility gained  from the product vs. utility lost by paying the price which = Utility  maximization which influences Purchase decision

- It is not that simple in the “real world”

Neoclassical Economics:

- People are fundamentally rational and will adjust their choices and  behaviors to best achieve their goals. Consequently, they will not make systematic errors.

- People’s preferences are completely stable and unaffected by context - People are eager and accurate calculators

- People are just as good at assessing future options as current options - People have no trouble resisting temptation

- People are almost entirely self-interested and self-centered - People do not care about fairness and only treat others well if doing so  will get them something they want

Behavioral Economics:

- People are irrational and make many errors that reduce their chances  of achieving their goals. Some errors are regularly repeated systematic errors.

- People’s preferences are unstable and often inconsistent because they  depend on context (framing effects)

- People are bad at math and avoid difficult computation if possible - People place insufficient willpower and often fall prey to temptation - People are often selfless and generous

- Many people care deeply about fairness and will often give to others  even when doing so will yield no person benefits

(full chart on slide 4 of October 25 & 30th Powerpoint)

Status Quo & Default Option

People tend to stick with whatever option is presented as the default option.

Opt in- need to do an act to get in

Opt out- need to do some act to get out

- Economics does not predict this, normally what you are given is what  you do, you always have the option but the “status quo” has a huge  impact on what people actually do

- Just change the status quo you can get people to act a certain way

Status Quo Bias:

Economics: Defining the status quo will not bias behavior

BUT

Behavioral Economics: Defining the status quo changes behavior Rationing

Rationing: Charge more for small amounts

Example in class: People will pay more for smaller amounts, for example  cookies. When split into “100 calorie” packages, people are willing to pay  more than the normal packaging of cookies.

Why: Customers are willing to pay for portion control.

Economics:

Individuals have self-control

Purchases are made relative to economic sacrifice

Behavioral Economics:

Some individuals lack self-control

To extent individuals are aware of this, they will pay a premium to avoid  being reliant on self-control

Number of choices

# of choices: Too many choices bad

In standard economics, more choices are always better because you can  simply ignore the less desirable choices.

BUT

When an experiment was conducted, it found that too many choices can be a bad thing

- More shoppers stopped and were attracted to the “greater variety”  BUT more shoppers actually purchased when considering the “lesser  variety”

Endowment Effect

- People value a thing more when it becomes theirs

- Ownership increases utility

- Loss aversion

Example in class: When students in every other university seat were given  mugs they were asked to report how much they would sell the mug for, on  the other hand, students that did not receive a mug reported how much they would be willing to pay for one.

- Results: Students with mugs priced them higher

Economics:

Perceived value is independent of ownership

Behavioral Economics:

Perceived value is NOT independent of ownership

“The ratio of fructose to cellulose is an objective and unchanging property of  apples, of course, but the experience of sweetness is a subjective property  that increases when an apple becomes my apple”

Situational Influences

Part of the “Decision process” in the consumer decision process model (Complete model found on slide 3 of “Situational influence” PowerPoint)

Situational Influence: includes all those factors particular to a time and place  that do not follow from a knowledge of the stable attributes of the consumer  and yet have an effect on current behavior.

- Do not need to know anything about the consumer and still know the  impact it has on behavior

- “State” variable

- Weather is a very strong situational variable, examples on slide 6 of  “Situational Influences” PowerPoint

o I.e. when weather turns cold, wet, or snowy Campbell’s soup  increases radio advertising

Nature of Situational Influence- The Four Types of Situations

The Communications Situation/Mood

Music impacts mood- that’s how it influences behavior

Affectiva impacts mood

Ad and brand attitudes are often influenced in a mood-congruent manner Positive mood does impact shopping behavior

Moods are not relatively stable and therefore are not tied to a specific event  of object

Consumers do actively try to manage their moods

The Purchase situation

i.e. with or without children- the same person behaves differently when they  go shopping with or without children, behave and buy differently

The Usage Situation

People eat differently at different times

i.e. fast food companies advertising for “breakfast foods” at dinner and  “dinner foods” at breakfast

The Disposition Situation

i.e. glass coke bottle

Summary of the five characteristics of situations

Situations can be described on a number of dimensions which determine  their influence on consumer behavior

1.Physical surroundings

2.Social surroundings

3.Temporal perspectives

4.Task definition

5.Antecedent states

i.e. Apple store

People abuse the apple store to “hang out” and this is a problem because  crowded people are conservative, and safety focused

- This is heightened when people are with other consumers they  consider a part of an “out group” (people they do not like or do not  consider their peers)

Physical Surroundings

Store Atmosphere is the sum of all the physical features of a retail  environment.

- Atmospherics influences consumer judgments of the quality of the  store and the store’s image.

- Atmosphere is referred to as servicescape when describing a service  business such as a hospital, bank or restaurant.

- Easier to sell warranties in crows because people want to be safe Temporal Perspectives- deal with the effect of time on consumer behavior

- Limited purchase time often limits search

- Internet shopping is growing rapidly as a result of the time pressures  felt by consumers

- “Satisficing”

- Product does not have to be the best, just has to be good enough  - Ads use time pressure, for example having a sale for only a certain  amount of time

Task Definition: The reason the consumption activity is occurring

- Major distinction between purchases for self vs gift

- Consumers give gifts for many reasons:

o Social expectations

o Ritualized situations

o To elicit return favors

Supermarket vs. French restaurant example

- Does not make sense in economics because they would not buy it for  themselves but for a gift people do not desire practical things - 84/97 people wanted the gift certificate to the French restaurant  because they would not normally buy it for themselves

Types of antecedent states:

Moods- transient feeling states that are generally not tied to a specific event  or object

Momentary Conditions- temporary states of being (tired, ill, having extra  money, being broke, etc.)

- For example, if someone is sad they may want to eat a pint of ice  cream before bed

Information Search

Part of the Decision Process of the Consumer decision process model (Complete Model can be found on slide 1 of “Information Search” PowerPoint)

The amount of search depends on the purchase involvement Searching for information is not free

Information search involves mental as well as physical activities that  consumers must perform

The initial search generally produces a set of guides or decision restraints  Search has benefits such as finding lower price or getting higher quality

External vs. Internal Search

Consumers continually recognize problems and opportunities so internal and  external searches for information are used to solve these problems and they  are ongoing processes

Internal:

Search of long-term memory to determine if

- A satisfactory solution is known

- What are typed of potential solutions

- Ways to compare the possible solutions

External:

If a resolution is not reached during internal search, then the search process  is focused on relevant external information

Ongoing search- is done to acquire information and because the process is  pleasurable

Information Sought

Consumer decisions require information about:

- Appropriate evaluative criteria

- The existence of various alternatives

- Performance of each alternative on each evaluative criterion o Evaluative criteria: the desired features or characteristics  required to meet a consumer’s needs

If a decision cannot be made, the information search continues

Types of Information Sought

Alternate view on slide 13 on “information Search” PowerPoint”  Example: Buying a laptop

Awareness set: Apple, Lenovo, Toshiba, Compaq, HP, Sony, Dell Evoked set: Lenovo, Apple Compaq

Inert set: Dell, Sony, HP

Inept set: Toshiba

A-I-D-A

- Attention

- Interest

- Desire

- Action

Sources

Internal information Active or Passively acquired Active Past searches & Personal Experience

Passive Low- involvement learning

External information Actively acquired Independent groups, personal  contacts, marketer information and experimental

Internet is a major search avenue

- Online information is expected

- Online information boosts sales (?)

- Online sources are viewed as valuable

- Online sources reduce salesperson’s role (?)

Three major strategic issues for firms:

1. How can they drive their information to consumers?

2. How can they drive their consumers to their information? 3. How can online selling be utilized or integrated with existing channels?

Web design is also critical, ongoing and repeat traffic requires relevant and  frequently updated content

Consumers need ongoing incentives to return such as:

- Product related news features

- User related discussion forums

- Updates on new products

Amount of Search

External information search is skewed toward limited search, with the  greatest proportion of consumers performing little external search  immediately prior to purchase.

Various measures of external information search:

1. Number of stores visited

2. Number of alternatives considered

3. Number of personal sources used

4. Overall or combination measures

Cost & Benefit chart found on slide 32 of “Information Search” PowerPoint Firm Strategies

Sound marketing strategies take into account the nature of information  search prior to purchase

Two dimensions of search are particularly appropriate:

1. The type of decision influences the level of search

2. The nature of the evoked set influences the direction of the search

In evoked set:

Maintenance strategy

Capture strategy Preference strategy Not in evoked set: Disrupt strategy Intercept strategy Acceptance strategy

Alternative Selection

Part of the “Decision process” portion of the consumer decision process  model

Three types of consumer choice processes:

1. Affective Choice

2. Attitude-Based Choice

3. Attribute-Based Choice

In slides: Car ads, comparative to one another

Consumer Choice and Types of Choice Processes:

Evaluative Criteria, Importance of criteria and Alternatives considered Evaluation of alternatives on each criterion decision rules applied Alternative Selected

Affective Choice

- Tend to be more holistic. Brand not decomposed into distinct  components for separate evaluation.

- Evaluations generally focus on how they will make the user feel as they are used.

- Choices are often based primarily on the immediate emotional  response to the product or service

Attitude- Based Choice

- Involves the use of general attitudes, summary impressions intuitions  or heuristics.

- No attribute-by-attribute comparisons are made at the time of choice

Attribute-Based Choice

- Requires the knowledge of specific attributes at the time the choice is  made

- Involves attribute-by-attribute comparisons across brands

Affective choice, attitude-based choice, attribute-based choice and rational  choice are all types of consumer choice processes

Decision Rules for Attribute-Based Choices

1. Conjunctive Rule

2. Disjunctive Rule

3. Elimination-by-Aspects Rule

4. Lexicographic Rule

5. Compensatory rule

(1-4 are all non-compensatory rules)

Conjunctive Rule

- Establishes minimum required performance for each evaluative  criterion

- Selects the first (or all) brands that meet or exceed these minimum  standards.

- Do not need to know rank of the attributes

- Need to be “sort of good” on everything

Disjunctive Rule

- Establishes minimum required performance for each important  attribute (often a high level)

- All brands that meet or exceed the performance level for any key  attribute are acceptable

- Do not need to know rank of the attributes

- Need to be very good at one thing

Elimination-by-Aspects Rule

- First evaluative criteria are ranked in terms of importance  - Second, cutoff point for each criterion is established

- Finally (in order of attribute importance) brands are eliminated if they  fail to meet or exceed the cutoff

- Start with most important and eliminate all those that do not meet the  minimum criterion- order is important

Lexicographic Decision Rule

- Consumer ranks the criteria in order of importance

- Then selects brand that performs best in the most important attribute - If two or more brands tie, they are evaluated on the second most  important attribute. This continues through the attributes until one  brand outperforms the others

- Start with most important and select that one- order is important

Compensatory Decision rule

- States that the brand that rates highest on the sum of the consumer’s  judgements of the relevant evaluative criteria will be chosen - The equation can be seen as follows:

Rituals

Example: Michael Jordan wore his North Carolina shorts underneath his  Chicago Bulls shorts in every game

Ritual Situations: is a socially defined occasion that triggers a set of  interrelated behaviors that occur in a structured format and that have  symbolic meaning

- Critical to marketers because they often involve prescribed  consumption behaviors

- Rituals seem to improve the consumption experience because they  lead to greater involvement and interest

- But rituals involve “process opacity”

Example in class: Oreo commercial

Rituals- Chocolate

Ritual condition: without unwrapping the chocolate bar, break it in half.  Unwrap half of the bar and eat it. Then, unwrap the other half and eat it

No-Ritual condition: participants relaxed for approximately the same duration and then ate the chocolate

Measures:

- Time taken to eat chocolate

- Subjective measure of enjoyment

- Subjective measure of taste

- Willingness-to-pay

Rituals- Baby carrots

Ritual condition: knock on table, take a deep breath eat baby carrot, repeat  three times (three different bags, with slightly different baby carrots) Random condition: Different acts, before each baby carrot sampling

Measures:

- Anticipated enjoyment

- Actual enjoyment

More generally: effects evident only if participants perform rituals, not just  observes ritual, effects are because of intrinsic interest (i.e. was more fun)

Possible test question: which group had higher anticipated enjoyment?  - Which group was more likely to enjoy it?

Decoy effect, Compromise Effect & Pain of Payment

•Decoy effect

•Sheng, Parker and Nakamoto (2005)

•Decoy effect refers to the phenomenon that the addition of a dominated  alternative into a choice set can increase the likelihood of an existing  alternative being chosen, given that the existing alternative is superior to the new entrant on both attributes examined (Huber et al.,1982)

Example taken from Huber’s 2004 presentation at ACR:

Ran Kivetz tests this with his MBA’s. He has half the group choose from the  three above and half the group choose from a set with the print alone  remove. Without the print decoy 40% choose the \$125 option, but with the  decoy 80% chose it! Notice that the .com subscription does not dominate  either the print subscription or the print +.com subscription for \$125,  however the print +.com at \$125 does dominate the print at \$125.

Is an illustration of asymmetric dominance effect which is an example of a  context effect. Violates regularity, choice share of an item cannot be  increased by adding an item

Add “useless option” Economics would predict no impact on choice share

Low vs. High Justification

Low justification – responses confidential

High justification – responses discussed and evaluated in class; responses  need to be publicly justified

Example: Beer Study

Using the decoy effect to influence others’ decisions

Slaughter, Kausel and Quinones (2011)

Imagine that the organization for which you work, Handelman United  Industries, is a multinational conglomerate.

You (and a few others) have been charged with the duty of selecting a plant  manager (PM) for the Omaha plant.

An executive search firm was given the task of evaluating five viable  candidates. The top two candidates are:

•BUT - you went to school with Johnson, and want to influence others to  select Johnson. So

you suggest three

candidates be

evaluated, Johnson,

Smith + one other.

Task – select one of

the three candidates

below (Bass, Frank or

Ellis), to maximize

chances that Johnson

is selected

Compromise effect

Sheng, Parker and Nakamoto (2005)

Simonson (1989) first introduces the concept of compromise effect. The  essence of compromise effect is that “an alternative would tend to gain  market share when it becomes a compromise or middle option in the choice  set”.

Compromise effect sustains when choices are binding

Pain of Payment

SPENDTHRIFTS AND TIGHTWADS

When people see prices, the area of the brain associated with pain  becomes activated.

WHEN ARE DIFFERENCES MOST APPARENT?

Tightwads

Feel too much pain → Spend less money than they should Spendthrifts

Feel too little pain → Spend more money than they should

Situational factors → Pain of spending

Utilitarian → Need, less painful

Hedonic → Want, more painful

When should tightwads and spendthrifts differ the most? Would you purchase a \$100 Massage?

Utilitarian

Therapeutic massage for back pain

Hedonic

Massage at spa

Demographic correlates

- Females: no significant shift either way

- Males: significantly likely to be tightwads

- Older consumers likely to be tightwads (some debate) - Engineering & science majors: likely to be tightwads*

- Humanities & social work: likely to be spendthrifts*

- may just be gender effects

KEY TAKEAWAYS: TIGHTWADS

Key is to downplay the price (if possible) – 1-Click/ Apple Pay/ credit  card etc.

Post Purchase Processes

Example: United Breaks Guitar

After he was not compensated, he put a song on YouTube and the song went  viral and United Airlines stock price decreased 10% costing shareholders  \$180 million among other things

Post purchase consumer Behavior:

Post Purchase Dissonance

Postpurchase Dissonance occurs when a consumer has doubts or anxiety  regarding the wisdom of a purchase made and is a function of the following:

- The degree of commitment or irrevocability of the decision - The importance of the decision to the consumer

- The difficulty of choosing among the alternatives

- The individual’s tendency to experience anxiety

After the purchase is made, the consumer may utilize one or more of the  following to reduce dissonance:

- Increase the desirability of the brand purchased

- Decrease the desirability of rejected alternatives

- Decrease the importance of the purchase decision

- Reverse the purchase decision (return before use)

Dissonance- doubt about choice

Guilt- not wrong choice between the two, choice just not good for you

- Chocolate example

Product Use and Non-Use

Product Use

Retailers can frequently take advantage of the fact that the use of one  product may require or suggest the use of other products, e.g., dresses and  shoes.

Retailers can promote such items

- Jointly

- display them together, or

- train sales personnel to make relevant complementary sales

Product Non-Use: occurs when a consumer actively acquires a product that is not used or used only sparingly relative to its potential use

Disposition diagram on Slide 26 of “Post Purchase Processes” PowerPoint

Evaluation Process Table 18-1 On slide 27 of “Post Purchase Processes”  PowerPoint

Dissatisfaction Process diagram on Slide 28 of “Post Purchase Processes”  PowerPoint

Dissatisfaction Responses:

Firms need to satisfy consumer expectations by

1.Creating reasonable expectations through promotional efforts, and 2.Maintaining consistent quality so the reasonable expectations are fulfilled.

Repeat purchasers continue to buy the same brand though they do not  have an emotional attachment to it.

Switching costs are the costs of finding, evaluating, and adopting another  solution.

Brand loyalty involves commitment to the brand – it is a biased behavioral  response expressed over time.

Net Promoter Score (NPS) is an indirect word-of-mouth (WOM) measure of  true attitudinal loyalty.

There are three categories of consumers:

1.Promoters

2.Passively satisfied

3.Detractors

NPS = Promoters minus Detractors

If a dissatisfied customer takes no external action they will have a less  favorable attitude toward the store or brand

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