Elasticity of Demand
Quality of product can determine the price of goods. In fact a firm producing high quality products expands new customer base due to customer referrals and amplification of positive word of mouth (Miller and Fishe 1999). This will in turn multiply overtime as the business grows and also will lead to increase in demand for the product or service. Also, taste and preference affects demand for a particular product (Begg & Ward 2009). For example, a customer who doesn't like to add butter to his staple diet will consume less of it than someone who does like butter. Later upon liking, his preferences may change in favour of butter and it supplements the demand for it to shift inward and finally affect the price of the product as shown in Figure 1.4. Similarly, the effect on price can be either due to short run or long run depending upon the type of goods. For luxury good there will be short term shift in demand due to change in life style while necessity good tend to have stable or long run demand curve.
(Source: Begg & ward 2009)
Coming to correlation of income to demand, when consumer income increases, disposable income increases and naturally it alters the consumption pattern (Begg & Ward 2009). This change in consumption pattern affects the demand of the product and accordingly its price. Demand for normal products are more during boom when consumer income increases, whereas during recession the income falls, resulting in customers opting for inferior or less superior products. Figure 1.6 illustrates the change in business cycle and highlights flow of money during recession and boom.
(Source: The Investor 2009)
Predicting price of competitor is the key in determining price of goods to attract a customer base. For instance in Bradford, NOMI Mobile card is being widely used by expatriate students to make cheap calls (3p per min) to India and it also allows call charge of 1p per min between 6AM and 6PM. But later, competition stiffened with Lyca entering this market space and started providing SIM at a competitive price of 1p for international calls. This attracted many expat students in choosing a substitute product in Lyca. So, in large market structures knowing the price of competitor holds the key in determining the price of an equivalent product. Thus the availability and the price of competitors affect the demand and finally drive the prices (Begg & Ward 2009). On the other hand demand for a product varies over different stages of a Product Life Cycle (Lowes 2010).
During each stage the number of competitors is different, so this leads to substitutability and differing elasticity's of demand. As shown in Figure 1.7, during launch of a product, the demand constantly increases whereas during maturity and declining stages the demand falls and hence prices will also follow the demand.
(Source: Sivers, D 2009)
Similarly technology can also affect the supply and change the price accordingly (Begg & Ward 2009); infact supply curves are drawn assuming a given technology. In this modern world, technology changes overnight due to multiple innovations, every passing day you can find new mobile phone models or LCD, LED television hitting the electronic stores. So to tackle this, if good innovative techniques are followed then supply curve will always shift towards higher production which in turn can meet the ever growing consumer demand. For example the supply for Walkman's were high during the mid-nineties and even in early 2000 but with the invention of MP3 Players and i-Pods, the demand for them dropped along with the prices of those products and supply, which eventually wiped them out of the market (Lowes2010).
On the other hand price of resources can vary the demand for a product (Miller & Fishe 1999), perfect example for this would be, in Middle East price of petrol is cheap compared to Asia, especially in India.
This is due to easy availability of crude oil in Gulf States complimented by natural resources. As a comparison, current petrol price in Bahrain is 100fills (equivalent to INR 12) whereas in India the same petrol price is INR 47.93. If we further analyse the actual cost of petrol in India during the same period it is INR 26.34, but when we add all government taxes (Press Information Bureau 2010) in:-
Excise duty: INR 14.35
Customs duty: 7.5%
Sales tax or VAT: 20%
it comes to 47.93 rupees per liter, which is the cost of petrol in Delhi (as of April-2010). So, Taxes can also change the market equilibrium price and quantity as shown in Figure 1.8.
Figure 1.8 above predicts the market equilibrium price and market quantity of the apple varies due to change in tax. (Miller & Fishe 1995).
Surge in Cotton Price creating market disequilibrium:
Following passage will discuss the reason for surge in cotton price due to market disequilibrium.
Market Disequilibrium: Supply Shortage
As world cotton acreage has declined, production has fallen to 15.3% in 2009/2010 crop year compare to 2004/05(Lifestyle Monitor 2010). Due to decline in cotton production, predicted cotton supply is far below than actual demand. The figure 2.1 shows fluctuation / mainly decrease in cotton stocks as a % of consumption over the past several years, but the higher prices are expected to drive substantial increase in cotton production in 2010/11. Once production is realigned with demand, cotton prices should move back towards their long-term averages as explained in Figure2.1 (Lowes 2010).
(Source: Meyer 2010)
However for cotton, the most important price driver is a supply shortage from China and Pakistan (WASDE Report. 2010), as showed in figure 2.3. This shortage can be overcome by increasing the price of cotton which in turn accelerates the cotton production and ultimately increasing the supply to match with market demand and create market equilibrium.
Click to Enlarge
Figure 2.2 Figure 2.3
Figure 2.2 above depicts demand for cotton among retailer outpaced cotton production which resulted in demand and supply shortage.
Also, soaring cotton price builds up pressure on fashion retailer market and as a result of which, NEXT warns the increase in price of garment between 5% and 8%and it was predicted to hit the total sales by 1-2 per cent (Meyer. 2010). As illustrated in figure 2.4, this situation creates inelastic demand, which indicates, for any change in price there will always be a small change in quantity demanded.
During price rise most of the consumers will try to cut down their expenditure by just reducing the quantity without compromising on the quality of product. So retailers while increasing their price must focus on product differentiation which increases the demand for their product and also secernate price depending on consumer taste and preference.
Say for example, even if NEXT increases its price by 8%(Meyer 2010), there are certain group of customer who would still prefer to buy NEXT products, so in such situations retailers can generate revenue by increasing the sales of such branded product by distinguishing the price across low income and high income generating customers. Below figure 2.5(Miller & Fishe 1995), illustrates the situation where demand for product in market A(low income consumer) is elastic whereas in market B demand for the product remain inelastic(high income consumer).Profit maximisation occurs when MC=MR.
Product differentiation is another technique which can be used to increase demand for the product and maximize profit (Miller & Fishe 1995). From figure 2.6 it can be observed that company will generate profit by selling 200 shirts at $25 for differentiating their product by changing the design of shirt, but in monopolistic competition other firms try to compete by bringing new design to the market, in such situation demand curve will shift left and touches the Average Total Cost as shown in figure 2.7 thus firm in this case will not generate any profit.Though product differentiation is a key to revenue generation, advertising is another factor which most of the fashion retailer use to acquire some degree of market control and increase demand during price rise.
(Source: Miller & Fishe 1995)
Alternative option for retailer and manufacturer is to cut down the cost and switch to man-made fibers such as polyester, synthetic linen, rayon and synthetic fiber instead of relying on 100% cotton material. To achieve this, retailer and manufacturer must follow the "Just in Time Management" strategy and discuss about the amount of cotton proposition required for the particular material without compromising on the quality of the product (Clifford, S. 2010). This option to some extent reduces the average total cost and marginal cost and improves profit margin during price rise.
To conclude, while this essay focus on the key economic price determinant factors with real time examples it also examines situations that allow the customer to pass on cost increase and various factors such as price discrimination, product differentiation, and advertising can allow fashion retailer to retain their profit margin. In real time, though options provided may not provide a applicable result to increase the profit, it can to some extent allow the firm to maintain their profit margin when the price of the good increases.