1a) Explain the key demand side drivers of price for a given good or service.

1b) Evaluate how effective a price discount will be in raising revenues during recession.

1a) The quantity demanded for a good is a major factor to affect its price. Some products which are in great demand can increase their prices to increase their profits. Sometimes they are forced also to increase prices as more demands means more production, so they need to increase their capacity which involves money. But in either case they are in profit only. For example Maruti Suzuki motors increased their prices stating that raw materials prices are hiking [1]. Though steel companies later announced a decrease but they kept up with their hike as they know they are in demand [2]. Below is a demand curve showing effect of increase and decrease in demand on a demand curve.

While some companies decrease prices to increase their demand as people always look for a cheaper substitute in the respective segment.

For more practical example we can look at Tata motors. They came up with the “Nano” car plan to boost their market share. Nano is a small segment car with price around INR 100,000 or just USD 2100 (current conversion rate) and they succeeded in getting business. 100,000 cars were booked even before its launch [3][4].

Now we will look at the key demand side drivers for a given good say cars. The car market is very elastic and this is because there are too many companies providing consumers with numerous options to choose.

Income effect

: The buying power of consumer increases with increase in consumer's incomes which results in greater demand of goods like cars. So to cash this increment car manufacturers increase their prices [5]. The other reason to increase price is that due to higher demands more production is required so to generate capital for expansion prices are raised. Below we can see that as demand increases the demand curve shifts right so prices are increased.

While in hard times such as global recession the demand decreases which results in decline in sales so car manufacturers are forced to cut down prices to attract customers. This moves the demand curve towards left thus lowering the price.


demand grows in line with population. With increase in population, number of consumers increases which results in more demand and bigger market. So car manufacturers' hike their prices as they have more consumer options. We can take India as an example, the car market is too vast in India, and therefore many car manufacturers do not worry before raising price, as they know they have many consumer options. The sales are just increasing with more population and increased incomes

Price of complement:

For any good price of its complement affects its demand a lot. In car industry oil is a major factor affecting car demands and thus affecting car prices. The interesting thing is that it has a very versatile effect on car market demand and pricing.

When oil prices hike there is more demand for hybrid and electric cars. So these manufactures raise their prices. For example “Reva” an electric car in India was in great demand last year due to oil price hike so they raised their car's price by INR 50,000 that is nearly a 17 % hike [6].Honda launched their hybrid car “civic” in India in November 2008 when oil price were sky high at around INR 13,65,000[7] but now as the oil prices have down this November they sold them around INR 8,14,000[8] .

Now where oil hike is good for hybrid and electric car manufacturers it is not a good sign for petrol or diesel cars. It leads in a noticeable decline in sales due to which car manufacturers lower their price to make customers feel as compensated.

This can be related to cross elasticity which measures responsiveness of demand of a good to change in price for another good.[11]


Easy finance options by banks:

This facility plays a major role in raising demand as well price of a car [9]. Due to easy financing options owning a car is not a big investment now as we just need to pay a small amount and rest is financed by some bank or finance company [10]. Though we pay interest on the loaned amount which means we pay lot more than the showroom price but no one minds that. This also leads car manufactures to raise their prices as when we are financing our car we just worry about the instalment amount, contrary to when we buy cash we emphasize on principal amount we pay for the car.

This has become a very popular system as everyone is happy in this place we are happy that we own our favourite car that too without a big burden, bank is happy that it is getting interest amount, car manufacturers are happy that their car sales are hiking without lowering their price.

Good advertising:

Advertising is an important factor for raising demand of cars. These ads are made to hit on psychology of public. Such that if an advertisement is hit among public there are more chances of the product to get hit. Resulting in, the car will be in great demand, prices will be raised, but people will pay because the product has become popular.

So we can see that increase and decrease in demand play a major role in pricing of a good.

1b)Recession in general is fall in gross domestic product for a period of time. So during recession production, employment, investments, household incomes, inflation, business profits all feel a setback . So offering discounts during this period can be a great move for various businesses for, if not generating profit at least broke even.

But this not as simple as it seems, pricing strategy in recession depends on the long term strategy for a product and its customer base. We will discuss the effects on car industry. With falling volumes and competitive environments, lowering prices is more likely to reduce revenue than increase it unless there is substantial uncontested volume increase offset. Discount can be offered in situations where the percentage increase in volume will offset the percentage decrease in price. But increased volume may not be consumed in recession. Also discount can be offered in low-value products/ services. Providing discount on high-value products/ services for example cars may undermine value proposition and will make it harder to profit when the upturn starts. In fact high-value products/ services can be taken off or limited during recession. For example General Motors developed both high and low-value cars to meet the needs of different customer base.

Now we see that car manufacturers do follow a strategy during recession. Just that the difference was in their approach, they called “discounts” as “offers” just as a rescue measure for the upturn period and saving their so called market dignity. For example Bavarian motor works or BMW was offering a 2.9% finance offer in United States on its cars they included the top end models too[13]. This offer could save your several thousand US dollars in other way this means you do not have pay several thousand dollars more which is ultimately a discount only. But how can BMW offer a discount! They have their market reputation which doesn't coincide with the word discount. Similarly Jaguar are offering 0% annual percentage rate on their luxury models for 5 years which could end up in saving of few thousand dollars. Some car manufacturers like Volvo are planning a different strategy that is they are offering more after sales services like extended warranty up to 3 years or 36,000 kilometres [19]. Honda motors are offering a lease of few hundred dollars a month on its super hit car civic.

But can these measures generate revenue for their respective companies? Majority answers would say no, because these measures are not effective enough, that too in a recession to lure customers to showrooms of names like BMW, jaguar etc. all these offers can offer is just getting their old stock moving or achieving break-even that is no profit no loss situation. The other major problem will be after recession as we know; all business cycles have the same pattern that's recession followed by recovery followed by rebound. Each phase has to be managed in anticipation of the next. So after recession when people will seek more such offers then unavailability of these offers could lead consumers to move up to other brands as car market is a very elastic market and a small change on price side could be bad for demand side. Though these offers could buy them some customers but not enough to get them back in profit. There are also customers who belong to a certain group that is recession proof industry employees' group. As we know recession affects every aspect of economy but then also there are kind of recession proof jobs like health care, medicine, police or criminal justice, federal jobs etc. The employees of these industries are potential customers during recession and they also can avail number of discounts which is in fact for the ones affected by the recession. But then also buying car is no joke and one in a thousand only would turn up to these offers to cash the opportunity. It is not that only one in a thousand only will be capable of buying a car but it depends on other factors also.

We are talking of recession and one of the major problems of recession is that people are generally mislead by media, in a particular way that they start using recession word without even clearly knowing that what are they talking about. This is a not good situation as it decreases consumer confidence and thus restricting their buying power also. This leaves car manufacturers with fewer options towards consumer side.

So for car industry the idea of giving discounts will not be a very effective measure in raising revenues but we cannot call it a useless measure also, it is just that we are going with the one more logical. As car industry is too big and investing in a car is very different from buying something from the retail store. They are way too expensive to be bought during recession when people think of saving money for essential things like medical and near future. The offers given, can for sure bring few customers who are not much affected by recession or have some spare savings for car but these one in a million customers cannot be termed as revenue generator for car company taking in account the size of the industry involved.

Source: Essay UK - http://buystrangestuff.com/free-essays/economics/key-demand-side-drivers.php

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