As we have noted, most pricing research has focused only on money: the dollar amount a consumer must spend to purchase a product or service. This research has recognized that the same dollar amount may be perceived differently by different individuals and market segments, depending on income levels and other variables. However, several important aspects of the dollar cost of offerings are not always considered. One of these concerns the source of funds for a particular purchase. We suspect that money received as a tax rebate, gift, interest, or gambling winnings has a different value to many consumers than money earned through work. Consequently, the dollar price of a particular item may be perceived differently by the same individual, depending on what sources of funds are used to pay for it.
Similarly, the actual price of a credit card purchase that will be financed at 16 percent for an extended period is much different from the price if cash is used. To consumers who are accustomed to carrying large credit card balances, this difference may be irrelevant; to others, the difference may forestall or eliminate a purchase. In addition, the type of work consumers do may affect how valuable a particular amount of money is to them, as well as affect their willingness to spend that money on particular products and services. Shipping costs and return shipping costs for Internet purchases increase dollar costs for consumers.
A number of methods can reduce the dollar amount spent for a particular item, although they often involve increasing other costs. For example, time, cognitive activity, and behavior effort are required to clip and use coupons, mail in for rebates, or download coupons from Internet sites. Shopping at different stores seeking the lowest price not only involves time, cognitive activity, and behavior effort but also increases other dollar costs, such as transportation or parking. Consumer Insight 18.1 discusses consumer price sensitivity to changes in money costs.
Consumer Insight 18.1
Consumer Price Sensitivity and Money Cost
Generally, as the money cost of a product increases, its sales will decrease because fewer and fewer consumers feel the product is a good value. The price sensitivity of consumers determines how many units will be sold at different price levels. If consumers in the target market are very price sensitive, sales will decrease significantly when prices increase. If consumers are not very price sensitive, sales will not decrease significantly if the prices are increased.
The target market for a product is generally viewed to be price insensitive (referred to as inelastic) when its price elasticity is greater than –1—that is, when a 1 percent decrease in price results in less than a 1 percent increase in quantity sold. The target market for a product is price sensitive (referred to as elastic) when the price elasticity is less than –1—that is, when a 1 percent decrease in price produces more than a 1 percent increase in quantity sold. The price elasticity for a product can be estimated by conducting an experiment or by using statistical techniques to analyze how sales have changed in the past when prices changed.
Various factors affect the price sensitivity for a product. First, the more substitutes a product or service has, the more likely it is to be price elastic (sensitive). For example, there are many alternatives for McDonald’s sandwich meals, and thus, fast food prices are typically price elastic, but branded luxury goods have almost no substitutes and are price inelastic (insensitive). Second, products and services that are necessities are price inelastic. Thus, medical care is price inelastic, whereas airline tickets for a vacation are price elastic. Third, products that are expensive relative to a consumer’s income are price elastic. Thus, cars are price elastic, and books and movie tickets tend to be price inelastic. The estimated elasticities for some commonly purchased items are shown below.
Based on these estimates, a 1 percent decrease in the price of clothing would result in only a 0.90 percent increase in the quantity sold in the short run but a 2.90 percent increase in the long run. So if you must have that new sweater today, you are much less responsive to a low price than if you can wait for the sweater to be on sale three months from now. In contrast, Americans aren’t going to change their gasoline purchases much in the short or long run, regardless of slight price decreases or increases. However, these elasticity estimates are based on relatively small changes in prices and can be very different for large price changes.