Figure 1: Elastic Demand
Demand will be price inelastic if the quantity demanded changes by a smaller percentage than price. Therefore the value of elasticity will be less than one (E<1), thus showing a vertical demand curve. For example, if a product is inelastic then the price increase will result in a revenue increase. This is because the slight decrease in quantity sold is less than the revenue gained from the price increase. Figure 2 shows that the total revenue changes as the price changes. The inelastic demand is between two points a and c. A rise in price from £4 to £8 will cause the quantity to decrease by a smaller amount which is from 20 to 15. Therefore the total revenue increase is from £80 to £120.
Figure 2: Inelastic
The determinants of price elasticity of demand are the availability of substitutes, luxuries and necessities and time period. The more substitutes there are for a good, especially close substitute, the more elastic will be the price elasticity of demand for the good. A rise in price will lead consumers to substitute other goods. However, if a good has fewer substitutes then consumers may find it difficult to replace, therefore the price elasticity will be low. Availability of substitutes is probably the most important influence on price elasticity of demand.
Necessities have more inelastic demand whereas luxury goods are more elastic. If the goods are necessity then the demand is unlikely to change for a given change in price. For example, people need salt, so even if there was large changes in the price of salt, it would not alter the demand for salt. However, if the goods were a luxury (elastic) then the demand would most likely change for a given change in price. For example, if the price of red cars slightly increased, demand is likely to decrease since substitutes are available for purchase (cars of different colours). The time period influences elasticity largely because the longer the period of time, the greater the knowledge of substitution possibilities by consumers.
The consumer’s perception of the product is an important issue for car manufacturers. A car manufacturer’s brand identity is therefore a key element to its success. Huge sums of money are spent on advertising to develop the specific brands. For example, BMW have a reputation for being high performance, high quality, luxury vehicles and they have a price tag to reflect this. They are seen as status symbol goods and can be the result of conspicuous consumption. The company MG Rover was once owned by BMW until it was dispensed in 2000 (Auto Car Magazine 2005). This had an affect on MG Rover as it slowly lost its brand identity, thus selling its models at slow pace. This indicates that MG Rover cars are elastic demand as Richard Bremner (2005) stated that less than 50 new models, City Rover and MG SV were sold at cheaper price after BMW dispensed MG Rover. If MG Rover cars were inelastic then the change in price would not affect demand as much. Furthermore, inelastic demand is also believed to be necessity, therefore if MG Rovers were inelastic then demand would be high and there would not be slow selling cars.
Factors that determine price elasticity of demand are the availability of substitutes, luxuries and necessities, the time period and the proportion of income spent on the good. Necessity goods are considered to be inelastic demand as consumers need it more and cannot find substitutes even when the price increases. This indicates that MG Rover cars are luxury cars therefore have more elastic demand. There are many close substitutes for MG Rover indicating that the price elasticity of demand would be more elastic. A rise in the prices of MG Rover cars will lead consumers to substitute other cars such as Ford, Vauxhall, BMW, Honda and many other different cars. Public transport is also a substitute to a car as it is becoming a more efficient way to travel.
Richard Bremner (2005) has stated that the only reason to purchase a MG Rover car would be because of price and loyalty to Rover, as well as reliability and good quality. However, an increase in the price will decrease the demand for MG Rover cars, as consumers would turn to other substitutes offering the same features or even with advanced technology at lower price. The horizontal product differentiation comes in the form of the size of the car, its colour, performance and technologies and this depends on the need or want of the customer. The vertical product differentiations are important features such as fuel efficiency, safety features, e.g. air-bags, central locking and other security features. The Auto car Magazine (2005) highlighted that MG Rover has introduced the new model ZT with airbags and with few sophisticated features. Consumers will look for these features as standard on every car and not as extras like many of the horizontal differences. Therefore, if the prices did rise, consumers may turn to other substitutes as it would not be necessity for them to buy the MG Rover.
The time period influences elasticity largely because the longer the period of time, the greater the knowledge of substitution possibilities by consumers. Therefore, consumers will understand the market better and take extra time to think carefully about different cars. However, the shorter the time period the more a car can become a necessity. This is due to less time available for consumers to choose a reliable and good quality car. Therefore, MG Rover should take the opportunity to advertise via television, bill boards, magazines and other forms of media and also offering lower prices in order to attract customers.
Richard Bemner (2005) has identified that MG Rover sales are mainly encouraged by the elderly market. Pensioners are more likely to buy MG Rover cars as they look for good quality and reliable cars to match their requirements. Furthermore, pensioners most likely look for luxury cars that do not have advance features, therefore this may be the reason why MG Rover does not spend there funds on updating features and advance technology so often.
MG Rover is in a competitive market therefore they are experiencing tough competition as their models are not the latest designs. This causes the demand to decrease as consumers would turn to other substitutes. However as they have a USP of selling cheap, it is the only reason why many consumers purchase the cars. MG Rover manufactures replicas of other cars, for example the Rover 400 in 1995 was based on a Honda Civic and the super mini in 2000 was based on the Indian-built Tata Indica. This indicates that MG Rover has low demand as their facelifts are not original. In order to raise the demand, MG Rover should decrease the price for cars which indicates loss in the short run but profit in the long run.
In conclusion, it can be seen that MG Rover cars have more elastic demand than inelastic demand. This is because as the price of cars changes the demand also changes. Consumers would most likely demand less for a MG Rover as the price of the MG Rover increases. This can be seen as consuming less or substituting other goods. The more the demand decreases as the price increases, the greater is the price elasticity of demand.
The consumer perception of the car is necessary for the continuing success of MG Rover. The brand must ensure quality at a reasonable price to satisfy the consumer’s needs. The consumers nowadays are well educated and know exactly what they want; therefore, improved prices would benefit the consumers. Furthermore, in order to increase sales MG Rover should manufacture modern designs for different age groups. This is can be done by introducing features such as DVD players, and other electronic features. To increase demand, MG Rover would need to advertise in order to get a wider market share and more recognition by the consumers. By taking this approach their demand would not fluctuate as much.
In general, if the price of a MG Rover decreases then the quantity demanded is expected to increase and therefore the price elasticity of demand would be negative.
References
Books:
Sloman. J, Sutcliffe. M, Economics for Business 3rd Edition. Prentice Hall (2004)
McGrath. D, Economics for Business, Module WorkBook, Semester 2 (2005)
Bibliography
Books:
Sloman. J, Sutcliffe. M, Economics for Business 3rd Edition. Prentice Hall (2004)
McGrath. D, Economics for Business, Module WorkBook, Semester 2 (2005)
Websites:
Price Elasticity of Demand
(Viewed: 15th April 2006)
MG Rover Cuts Prices Article
(Viewed: 16th April 2006)
