Elasticity of Demand
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In this paper, we examine Happy Pet Clinic, a local veterinary clinic, and how the principles of elasticity of demand might frame its pricing decisions and planning. As a small practice, every change the managers make can have a significant impact on the clinics income. Price Elasticity of Demand, Cross Price Elasticity of Demand, and Income Elasticity of Demand concepts can be used to analyze and estimate how prices changes may affect the clinics bottom line
Professional Vet Brand pet food is the exclusive brand of pet food carried at the Happy Pet Clinic. This pet food is considered a premium brand and competes with other high-end pet foods but is available only at veterinary offices. The recent recall in over 100 brands of pet food brought many clients into the clinic to find “safe” brands. Due to high quality ingredients exclusively from North America, the clinic felt comfortable in recommending the food to clients who had fed one of the more than 100 brands of recalled foods and were looking for a safer brand of food to change their dogs and cats to. At the same time, the cost of Professional Vet Brand to Happy Pet Clinic has increased, due to rising gas prices causing increased transportation costs.
Price Elasticity of Demand expresses the relationship between the price of a product and the demand for that product. What will happened to the demand for Professional Vet Brand sales if the clinic raises the price of the it? Though some current clients may not buy the pet food at the new price, other clients will continue or even join in purchasing it, as it is one of the few pet foods not affected by the pet food recall. To calculate the Price elasticity of demand of Professional Vet Brand it was estimated that sales would drop from 98 bags sold per month to 90 bags sold per month:
Original Price = $15 bag (P1)
New Price = $17 bag (P2)
Quantity Demanded at the Old Price = 98 (Q1)
Quantity Demanded at the New Price = 90 (Q2)
Price elasticity of demand is the percentage change in the quantity demanded, divided by the percentage change in a goods price.
PED = [ ( 98 – 90 ) / 98 ] x 100 ) / [ (15 – 17) / 15 ] x 100
PED = ( 8.16 ) / ( -13.33 ) = – 0.612
If PED > 1, then demand is elastic, or sensitive to price changes; if PED = 1, then demand is unit elastic, or changes in proportion; if PED < 1, the demand is inelastic, or not sensitive to price changes. In this case, PED = 0.612 ; thus, if our estimates are correct, changes in price will not affect demand very strongly.
Every year the clinic does an analysis of its costs of operation and what competing clinics in the area charge, and every year raise their veterinary examination prices by conservative amount. They are reluctant to raise their prices further, as they are afraid that this will lower the demand for Happy Pet Clinic services, and increase the demand for exams at the less expensive Jolly Pet Clinic two blocks away. People will still need their pets examined, and since both clinics are located near one another, some people are readily willing to substitute Jolly Pet Clinic for Happy Pet Clinic.
By using Cross Price Elasticity of Demand the change in demand for the Happy Pet Clinic services can be quantified. Cross price elasticity of demand measures the sensitivity of one quantity demanded to the change in price of another good. To calculate the cross price elasticity of demand it was estimated that a 5% rise in the cost of Happy Pet Clinic exams would increase the demand for exams at Jolly Pet Clinic by 10%.
Cross price elasticity of demand is percent change in the demand of a good divided by the percent change in the price of the other good.
% D Demand at Jolly Pet Clinic = 10%