Elasticity and Pricing Power

Firms and Nonprofit Institutions Often Recognize and
Exploit Differences in Price Elasticity of Demand.
All the buyers of a product traded in a highly competitive market pay the same
market price for the product, regardless of their individual price elasticities of
demand. If the price rises, Jones may have an elastic demand and greatly
reduce her purchases. Green may have a unit-elastic demand and reduce his
purchases less than Jones. Lopez may have an inelastic demand and hardly
curtail his purchases at all. But all three consumers will pay the single higher
price regardless of their respective demand elasticities.
In later chapters we will find that not all sellers must passively accept a “one-forall” price. Some firms have “market power” or “pricing power” that allows them to
set their product prices in their best interests. For some goods and services,
firms may find it advantageous to determine differences in price elasticity of
demand and then charge different prices to different buyers.
It is extremely difficult to tailor prices for each customer on the basis of price
elasticity of demand, but it is relatively easy to observe differences in group
elasticities. Consider airline tickets. Business travelers generally have inelastic
demand for air travel. Because their time is highly valuable, they do not see
slower modes of transportation as realistic substitutes. Also, their employers pay
for their tickets as part of their business expenses. In contrast, leisure travelers
tend to have elastic demand. They have the option to drive rather than fly or to
simply not travel at all. They also pay for their tickets out of their own pockets
Next take discounts for children. A child takes up a full seat at the baseball game
but pays a lower price than an adult. A child snowboarder occupies the same
space on a chairlift as an adult snowboarder but qualifies for a discounted lift
ticket.
Finally, consider pricing by colleges and universities. Price elasticity of demand
for higher education is greater for prospective students from low-income families
than similar students from high-income families. This makes sense because
tuition is a much larger proportion of household income for a low-income student
or family than for his or her high-income counterpart. Desiring a diverse student
body, colleges charge different net prices (= tuition minus financial aid) to the two
groups on the basis of price elasticity of demand. High-income students pay full
tuition, unless they receive merit-based scholarships. Low-income students
receive considerable financial aid in addition to merit-based scholarships and, in
effect, pay a lower net price.
It is common for colleges to announce a large tuition increase and immediately
cushion the news by emphasizing that they also are increasing financial aid. In
effect, the college is increasing the tuition for students who have inelastic
demand by the full amount and raising the net tuition of those with elastic
demand by some lesser amount or not at all. Through this strategy, colleges
boost revenue to cover rising costs while maintaining affordability for a wide
range of students.
There are a number of other examples of dual or multiple pricing. All relate
directly to price elasticity of demand, to be taken up in Chapter 12.
Create your own individualized response to this prompt. In addition, you
might consider these questions.
• What are your instinctive “first reflections” on this piece?
• What have you learned about Elasticity of Demand from this chapter
that helps you to understand how an airline can distinguish the
demand for travel between business travel versus leisure travel?
• How might a university make optimal pricing decisions relating to
tuition between students from high income versus low income
families?