Business

Economics

CO-EXISTING PRICES AND

CROSS-ELASTICITY OF
DEMAND

Bitan Ghosh
Adrika Guha
Uttam Kumar
Indian Institute of Foreign TradeKolkata
Campus
 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

Table of Contents
Introduction .................................................................................................................................. 3
The Case ........................................................................................................................................ 3
Justification of the Authors Conclusion .................................................................................................. 4
Real-Life Example from the Indian Context ................................................................................. 4
Our explanation about the Indian context with respect to the Author ................................................. 7
References .................................................................................................................................... 8

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

Introduction
The relationship between price and demand (quantity) has been the subject of extensive
studies across many product categories, regions, and stores. Elasticity estimates have also
been used to improve pricing strategies and price optimization efforts, promotions, product
offers, and various marketing programs. The price elasticity of demand measures the
responsiveness of consumers to change in the price of a product. It is commonly computed
as the percentage change in demand or quantity divided by the percentage change in price.
Since the development of the concept of price elasticity of demand from marginal utility
theory in 1890, price elasticity estimation has long been the subject of many studies, and
takes prominent place in many econometrics text books, several publications, market
research and business consultation efforts.
Estimation of price elasticity serves many purposes. Once the demand response to price is
known, it is possible to implement store- or customer-specific promotion expenditure and
pricing strategies including choice of regular prices, magnitude of discounts, product
bundling, product positioning and pricing of private labels. Price elasticity estimation have
been the subject of many studies for various product groups including gasoline, timber,
cigarettes, alcoholic beverages, online transaction data, sales of digital scientific information,
a range of postal products and several consumer good items. Variability of price elasticities
were measured across store chains, store and national brands, regions, time periods and
stages of product life cycle. Also, price elasticity estimations are powerful tools to optimize
prices for improved revenue and profits and develop competitive strategy analysis and
market power indices.

The Case
At the university where the Author works, two retail outlets, which are situated about fifty
metres apart, sell identical cans of fruit juice but charge markedly different prices (P) for their
product: $1.60 and $2.10. The two shops are owned and operated independently of each
other, and neither is controlled by the university. The two products are physically identical
and anecdotal evidence indicates that the services that accompany them (seating,
friendliness, cleanliness, spaciousness, temperature, etc.) are perceived by the consumers to
be identical. Prices are clearly displayed so there is perfect knowledge. Prices have remained
at their present levels for several months, so it is reasonable to assume that an equilibrium
has been reached.
Since the two products are substitutes, elementary economic theory indicates that the value
of the elasticity of demand for each of them will be infinite. In this case, however, although
the proportional price difference (using the mid- point formula) is, at 27%, substantial, cross-
elasticity of demand for each of these goods appears to be very low and is probably
approximately equal to zero. Anecdotal evidence from my students and colleagues indicates
that their choice of retailer is random. There are no statutory price controls and it is most un-
likely that there exists a price-discrimination cartel. It therefore follows that at least one of
the two retailers are not aiming for maximum profit. Although there is no evidence that
indicates that either or both of these two businesses, or their clientele, are unusual, this
conclusion is not predicted by elementary economic theory.

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

Justification of the Authors Conclusion
Conventional theories of cross price elasticity referring demand side relationship among
different products, are almost always articulated in terms of consumption and not in terms
of the individual consumers transactions within the marketing system.
This means that the conventional way of looking at substitutes, for example coffee and tea,
does not help the retail manager to determine how best to assemble or modify his
assessment. But this case study on coexisting prices and cross elasticity of demand are
showing about two retail outlets at the university which are situated about 50m apart and
selling identical cans of fruit juice at different prices. Since the two products are substitutes,
so the value of elasticity of demand for each of them will be infinite. It is widely taught in
introductory economics courses that the principle determinant of price elasticity of demand
for a product is the extent to which it is perceived by purchasers to be the luxury or a
necessity. This does not explain the present case through that conventional way.
In reality the case of cross price elasticity of demand there is no reason to believe that the
cheaper outlets sales would fall if its price rose towards or even beyond the other firms price.
This is because of the rational behavior is not present here. A theory has no value if it
describes a world that does not exist.

Real-Life Example from the Indian Context

We found out that the most similar example in the Indian context is that of Amul and Mother
Dairy. For instance, we can take the example of Amul Milk and Mother Dairy Milk.


Amul India Mother Dairy

Company

Product Name Amul Gold Mother Dairy Milk
Pasteurized milk Amul milk Pasteurized milk, meets the PFA
Description meets the PFA standards for the standards for the respective type
respective type of milk. of milk
Poly Pack - 500ml, 1000ml, 5 Ltr
Poly Pack - 500ml, 1000ml
Packaging *
* In Selected markets only

Table 1. About the Product

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

Company Amul India Mother Dairy
FAT(%) 6.0 min FAT(%) 6.0 min
Composition
SNF (%)* 9.0 min SNF (%)* 9.0 min
Serving Size 200 ml 250 ml
Amount per 100 ml 110 ml
Energy 87 kcal 87 kcal
Energy from FAT 54 kcal 54 kcal
Total FAT 6 g 8 g
Saturated FAT 3.7 g 3.9 g
Cholesterol 16 mg 16 mg
Total Carbohydrate 5.0 g 5.0 g
Added Sugar 0 g 0 g
Protein 3.3 g 3.0 g
Calcium 150 mg 150 mg
Phosphorus 130 mg 130 mg
Sodium 50 mg 50 mg
Thiamine 42 mcg 42 mcg
Riboflavin 120 mcg 120 mcg
Niacin 100 mcg 100 mcg
Folic Acid 7.5 mcg 7.5 mcg
Vit. A(Retinol) 65 mcg 65 mcg
*Approx. values
48 Hours from the date of packing if kept under
Shelf Life
refrigeration below 8C
Storage condition Under Refrigeration (Below 8C)

Table 2. Product Specification

Company Amul India Mother Dairy
Amul Milk is the most hygienic Packed with energy and
liquid milk available in the market. nutrition thats essential for
Product It is pasteurized in state-of-the-art growing kids. It makes them
Features processing plants and pouch- stronger from within and
packed to make it conveniently keeps them active and
available to consumers. healthy.
Direct consumption, Making of: Direct consumption, Making
Application Tea or Coffee, Sweets, Khoa, Curd, of: Tea or Coffee, Sweets,
Buttermilk, Ghee Khoa, Curd, Buttermilk, Ghee
Market
All over India All over India
Availability

Table 3. Product Features, Application and Market Availability

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

A survey was performed with respect to both Amul and Mother Dairy Milk and the following
results were found.

How will you rate the quality of Amul Milk/ Mother Dairy Milk?
Excellent Good Average Poor
Amul Milk 31% 44% 19% 6%
Mother Dairy Milk 25% 43% 22% 10%

Figure 1

How will you rate the Amul Milk/ Mother Dairy Milk in terms of value for money?
Excellent Good Average Poor
Amul Milk 25% 42% 18% 15%
Mother Dairy Milk 27% 43% 24% 6%

Figure 2

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

Our explanation about the Indian context with respect to the Author
Our explanation would not be any different from that of the Author for reasons more than
one. Firstly a theory has no value if it describes a world that does not exist. Therefore any
economic theory has to be relevant to the world we live in. In spite of progress in the field of
economics there is no absolute benchmark for a product to do well or not survive the market.
History has seen major predictions by best of the people in business having gone wrong
sometimes, despite thorough research and analysis of the market trend. What makes it really
difficult is rational behaviour of the consumers or the target market. While consumers as in
the present case do not mind switching to a substitute, it is their rational behaviour that drives
them to take the best decision in a given situation like unavailability of juice or overcrowded
shop at peak hours.
While for any business, maximising profit is the ulterior motif of the seller but increasing or
decreasing price of the good alone cannot lead to improved sales. The seller charging less is
aware of its rivals price yet he is ok with his own pricing suggests, there likely to be some
consumer behavioural pattern that doesnt affect his sales on the whole. Again it may also be
seen as a rational behaviour on the part of the seller with low pricing not to attempt to get
the highest return as it does allow for the consideration of risk at that point in time. A persons
aversion to risk may be considered rational at multiple levels depending on his exact goals
and circumstances. May be the seller has some long term strategy in place or might come up
with an alternative approach to increase sales without disturbing the price of juice. He could
also be having an alternative source of income the reason why it doesnt affect him on making
less money than his rival juice seller in this particular business. These are some factors that
have not been considered while assessing the case on co-existing prices and cross-elasticity
of demand.
Thus conventional theories provide only a direction to evaluate situations based on the
important factors that usually influence the cross-price elasticity of demand in case of
substitutes. However there are innumerable indirect factors that affect the performance of
any product in the market like separate source of income, starting of a business with capital
as opposed to raising funds to start a business and so on. To analyse and evaluate considering
all of the factors, both direct and indirect is not theoretically possible to asses a real time
situation.

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 CO-EXISTING PRICES AND CROSS-ELASTICITY OF DEMAND

References

1. Empowerment Case Studies: National Dairy Development Board
2. www.indiadairy.com
3. www.google.com