Price Elasticity of Demand
This is the key formula you should use: E = (∆Q/ Q) / (∆P/ P)
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
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?
E = -0.5
∆Q = X (to be determined)
Q = 100
∆P = $10 (i.e. $30-$20)
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
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?
We also discuss several other topics like Who are the decision-makers for b2b selling?
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)
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) If you want to learn more check out What happens if the numbers are not whole numbers?
‘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
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?
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 We also discuss several other topics like What is the cognitive model for?
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?
E = -2
∆Q = 50 (i.e.150-100) We also discuss several other topics like What are the different types of volcanoes and their connection to tectonic environment?
If you want to learn more check out Who is tutankhamen?
We also discuss several other topics like Spanish built more than how many catholic churches?
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
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
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”
- 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
- 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
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.
Individuals have self-control
Purchases are made relative to economic sacrifice
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.
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”
- 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
Perceived value is independent of ownership
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”
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
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)
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
- 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
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
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
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
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
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:
Capture strategy Preference strategy Not in evoked set: Disrupt strategy Intercept strategy Acceptance strategy
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
- 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
- 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)
- 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
- 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
- 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:
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
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
- Time taken to eat chocolate
- Subjective measure of enjoyment
- Subjective measure of taste
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
- 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
•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
Smith + one other.
Task – select one of
the three candidates
below (Bass, Frank or
Ellis), to maximize
chances that Johnson
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?
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?
Therapeutic massage for back pain
Massage at spa
- 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
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
- 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
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:
NPS = Promoters minus Detractors
If a dissatisfied customer takes no external action they will have a less favorable attitude toward the store or brand