Question

Some elasticity questions.

--Some auto manufacturers complain that they have no "pricing power" in the market due to the entry of many new models and manufacturers. Interpret this assertion in terms of demand-supply curves. Include some graphs with your answer! (If you wish, feel free to bring in outside information, beyond the textbook.)

-- In the light truck market, Ford's market share is approximately 50 percent (F-150, F-250, etc). GM's market share is about 20 percent. Individuals buying trucks tend to have some brand loyalty, while businesses buying trucks are more price sensitive. Can you infer anything about the price elasticity of demand for Ford trucks relative to the elasticity for GM trucks? How does it matter who is buying them? Also, if one manufacturer faces a less elastic demand, what might you infer about its price-cost margin (that is, its variable profit earned per truck sold)?  Be careful to define the "product" you are discussing! Does it seem better to define many "narrower" products, and discuss how they are related through markets, or to define "broader" categories?  (This is perhaps the most important and most difficult part of using demand-supply models: How do we define the "products" and "markets" essential for our analysis? Textbooks seldom discuss it but it is important in the real-world.)

Answer 1

- - Pricing power is directly related to the price elasticity of demand. If a product is desirable, so much that demand is price inelastic and even if the company raises the price, the demand wouldn't get much affected, and hence gives the company/firm the power to profit more than in case the demand was price elastic. In case the demand becomes less inelastic, ie more elastic, an increase in price would lead to a more decrease in demand, and the pricing power of the firm would decrese. The demand might become more elastic, if the product which was so desireble, is being started to produce by more firms by entering the market, supposedly after seeing the profits that can be taken by the pricing power. It is usually in case of monopolistic competition, where yet non-homogeneous, but similar products are produced, and there is a feasibility of entering new entrants in the market. The demand and supply comparisons are as in the graph below.

For a change in price from P1 to P2, the demand decreased from Q1 to Q3 under more elastic demand, and from Q1 to Q2 under less elastic (inelastic) demand, which decrement is less than that of more elastic demand. The pricing power is hence more in demand that is less elastic, than the demand that is more elastic.

One such example is Apple, which is, arguably, a monopolistic firm in the market of smartphones. Apple's pricing power have surely reduced after the entry of Android powered smartphones, which are sold at much less higher-than-marginal-marginal-cost price.

- - As stated, Ford's market share in light truck market is 50% while that of GM is 20%. Infering the price elasticity of both of these firms, we assume that both do change price almost equally. As faced several price changes, the Ford's demand shares are 30% more than that of GM, suggesting that price elasticity of GM is more than that of Ford aggregately (meaning both businesses and individual). Hence, Ford has more pricing power than that of GM. If taken one at a time, it can not be stated whether price elasticity of demand is more or less in case of individuals and businesses. But what can be said is that, supposing that the businesses and individial exist equi-proportionally, ie both are 50% of the total, one can say that the the statement of pricing power is true for both, and ealsticity of Ford is relatively lesser than the elasticity of GM.

Who buys what does matters as it affects the elasticity. If individual exists much more than the businesses, one can say that, as they stick to brands, individual's demand curve is less elastic for Ford than that of GM, suggested by the market share of the Ford. It might be, or might not be, just the opposite in case of business.

If manufacturer faces less price elastic demand, which basically means that for a 100% increase in price, the demand decrease would be less than 100% (about 30% to 85%), then price could be rised to increase the profit, up to some level. It would not be the case if demand was more elastic, and a 100% increase in price would decrease more than 100% (or say, 120%). Hence, the price cost margin, which can, arguably, be a measure of the pricing power, would be higher in case of less price elasticity of demand, than more price elastic demand.

Last, but certainly not the least, the defining of product is quite crucial. If one takes the market of smarphones, it can be argued as a monopolistic maket, but if one takes the market of iOS smartphones, the concerning market will be a monopoly with much less price elastic demand, and hence more pricing power. A narrower product, if more than usual desirable, will have inelastic demand, while a broader product, however much desirable, will have less inelastic demand. If the product is less desirable, the narrower product will give much inelastic demand, than the broader product (it will aruably be less inelastic in this case). In general sense, the magnitude of price elasticity, in terms of effect, is higher for the narrower and lesser for the broader product.