IB Business Management HLTopic 4 — MarketingPaper 1 & 2HL only~12 min read
Pricing Tactics for Tougher Markets
These are the HL pricing tools, and they all answer the same question in different ways: how much can we actually change our price before customers walk away? Price elasticity of demand is the number that answers it, so everything here leads back to it.
📘 What you need to know
Dynamic pricing: prices move with demand, minute by minute, to fill capacity and maximise revenue.
Competitive pricing: matching or undercutting rivals to protect market share.
Contribution pricing: set a price above the direct costs so every sale contributes towards indirect costs.
Price elasticity of demand (PED) measures how much quantity demanded responds to a price change.
PED = % change in quantity demanded ÷ % change in price. The answer is normally negative.
Elastic (bigger than 1, ignoring the sign): cutting the price raises total revenue.
Inelastic (between 0 and 1): raising the price raises total revenue.
PED depends on substitutes, brand loyalty, share of income, luxury or necessity, and time.
Dynamic pricing
Dynamic pricing means charging different prices at different moments, based on how much demand there is right now. Prices go up when demand is high and capacity is nearly full, and down when there are empty seats, rooms or slots to fill.
Dynamic pricing suits businesses with fixed capacity and perishable stock: hotel rooms, airline seats and concert tickets are worthless the moment the date passes.
Dynamic pricing helps because
But it hurts because
Revenue that a fixed price would have lost is captured, both at the peak and in quiet periods
Customers who find out they paid more than the person next to them feel cheated
Capacity is used properly — empty seats and rooms are filled at a lower price rather than left unsold
The systems need algorithms and technology that small businesses cannot afford
Prices can respond within minutes when the market moves
Big price rises during an emergency look like profiteering and damage reputation
The data shows how customers react to price, which improves future decisions
Hidden pricing rules create distrust, because nobody knows what the fair price is
Competitive pricing
Setting your price by looking sideways at rivals rather than at your own costs: matching them, undercutting them, or promising to refund the difference if a customer finds it cheaper elsewhere.
It is comfortable for customers, because the price meets their expectations and feels fair. It also protects market share in price-sensitive markets. The danger is the race to the bottom: if everyone matches everyone, prices only ever fall, margins get squeezed, and no business can charge for being better.
Contribution pricing
Contribution pricing sets the price above the direct costs of making the product, so every sale contributes something towards the indirect costs the business has to pay anyway.
Contribution per unit
Contribution = selling price − direct (variable) cost per unit
The point is that a sale making a small contribution is better than no sale at all, because the rent and salaries are being paid either way. It only works if the business knows its costs accurately and the price still looks reasonable to the market.
Price elasticity of demand
PED answers the question every pricing decision depends on: if we change the price by 10%, what happens to the number we sell?
Price elasticity of demand
PED = % change in quantity demanded ÷ % change in price
Read the axes carefully: price is vertical, quantity horizontal. The elastic line is close to flat because customers react hard to any change.
WORKED EXAMPLE 1
A firm raises the price of its trainers from $20 to $22. Weekly sales fall from 500 to 440 pairs. Calculate the PED and comment on the effect on revenue. [4 marks]
Step 1: Percentage change in price(22 − 20) ÷ 20 × 100 = +10%Step 2: Percentage change in quantity(440 − 500) ÷ 500 × 100 = −12%Step 3: DividePED = −12 ÷ 10 = −1.2Step 4: Check the revenueBefore: 20 × 500 = $10,000. After: 22 × 440 = $9,680PED = −1.2, demand is elastic, revenue fallsSay “demand for the product is price elastic”, not “the product is elastic”. It is the demand that responds, not the trainers.
WORKED EXAMPLE 2
A bakery cuts the price of a loaf from $2.00 to $1.80. Daily sales rise from 400 to 420. Calculate the PED and advise the owner. [4 marks]
Step 1: Percentage changesPrice: −0.20 ÷ 2.00 = −10%Quantity: +20 ÷ 400 = +5%Step 2: DividePED = 5 ÷ −10 = −0.5Step 3: Check the revenueBefore: 2.00 × 400 = $800. After: 1.80 × 420 = $756PED = −0.5, inelastic, so the price cut lost $44 a dayAdvice: reverse it. For an inelastic product like bread, a price rise would raise revenue.
What makes demand elastic or inelastic
Substitutes. Plenty of alternatives means elastic demand; few alternatives means inelastic.
Brand loyalty. This is the point of all that branding — loyal customers make demand more inelastic.
Share of income. Cheap everyday items barely register in a budget, so demand is inelastic. Expensive purchases are elastic.
Luxury or necessity. Necessities are inelastic; luxuries are elastic.
Time. Over a longer period people find alternatives, so demand becomes more elastic.
Turn PED into a decision, every time. Elastic demand? Lower the price to raise revenue. Inelastic demand? Raise it. If your answer stops at the number, you have only earned half the marks.
💡 Exam tip
Work out both percentage changes before you divide. Writing them down separately earns method marks.
Keep the negative sign, and remember −1.5 is more elastic than −0.3, not less.
Always finish with the effect on total revenue, not just the value of PED.
Say “demand is price elastic”, never “the product is elastic”.
For dynamic pricing, name the fixed capacity: seats, rooms, tickets. That is why it applies.
Connect back to branding — loyalty is how a business makes its own demand more inelastic.
⚠ Common mix-up
Dividing the wrong way round. Quantity change goes on top, price change on the bottom.
Assuming a negative PED is a mistake. It is normal, because price and demand move in opposite directions.
Confusing elastic with inelastic. Elastic stretches: a small pull produces a big change.
Thinking a price cut always raises revenue. Only when demand is elastic.
Contribution is not profit. It is what is left after direct costs, before indirect costs are paid.
Competitive pricing is not predatory pricing. Matching a rival is legal; destroying one is often not.
Up next: Promotion and Advertising Methods — above, below and through the line, and how to choose when the budget is small.
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