Tourist price sensitivity and the elasticity of demand: the case of BC ferries B

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Tourist price sensitivity and the elasticity of demand: the case of BC ferries

Based on what you know about demand and demand elasticity, give an assessment of the method the author uses to calculate the ferry transport price elasticity. Feel free to comment on the data and assumptions used in the calculations. Are the actual estimates what you would expect for this type of service? Comment briefly. (Article is below)

http://agrilife.org/ertr/files/2012/09/275_a-1-4-4.pdf

Price Elasticity The concept of price elasticity deals with how responsive consumer demand is to a change in price. If a price increase occurs (P1 to P2), a corresponding change in demand (Q1 to Q2) may occur. If demand hardly varies with a change in price, we say that demand is inelastic. If demand changes greatly, we say the demand is elastic (Kotler, Bowen & Makens, 1996, p.387). Ratio used to determine price elasticity: % change in quantity (Q) demanded = price elasticity % change in price (P) The ratio compares the proportion of change in demand with the proportion of change in price. For example if demand falls by 5% with a 5% increase in price, then the elasticity ratio is – 1.0. In this case the seller’s total revenue stays the same, with 5% fewer items sold at a 5% higher price preserving the same total revenue. Elasticity ratios 1 typify inelastic demand, whereas ratios 1 underscore an elastic response and a price sensitive market 1 (Yoon & Shafer, 1996).

Study A study was commissioned by the British Columbia Hotel Association in early 1998 and conducted by the Tourism Management Department of the University of Victoria’s Faculty of Business. The study involved a mail survey of 448 mainland B.C. residents. Initially, 51 percent of the sample (n= 230) completed surveys, however, a further 8 respondents failed to qualify as pleasure travellers. The questionnaire asked several related questions concerning price sensitivity to associated trip expenses, such as accommodation, attractions and meals before focussing on the respondents’ specific reaction to two transportation price scenario questions. They were asked what their reaction (projected # of trips that year) would be in light of a 20 percent decrease or increase in ferry fares.

Survey Results The demographic and travel behaviour characteristics of the sample was similar to the domestic tourist profile that has emerged over the past ten years in Tourism Victoria’s annual exit surveys. The sample responses indicated most tourists took pleasure trips to Vancouver Island between July and September, they made 3.1 round trips a year on the ferry system, their pleasure trips generally lasted 3 days, their average annual household incomes were in the $50,000 - $59,999 range. Furthermore, a breakdown of their typical trip expenses to Vancouver Island produced a per diem expenditure of C$251.16 which closely approximates the figure of C$240 per day produced by the previous Tourism Victoria exit survey (Tourism Victoria, 1996). In terms of their general price sensitivity to a Vancouver Island visit most found it offered a good or acceptable value. Where their assessments were recorded on a scale of 1 representing very good value through to 5 representing very poor value, all the principal ingredients of a visit were in the 2-3 range (Table 1). However, it is noticeable that the poorest value rating was for ferry transportation. This confirms that it was a marketing issue at the time of the study, and supports the more individual responses outlined in Table 2.

Table 2 refers to the respondent’s individual perception of the relative importance of various trip components to their overall trip planning. It is notable that their highest concern involved the cost of the ferry trip to Vancouver Island, followed by the overall anticipated costs. Thus for the individuals concerned the most immediate factor in travelling to Vancouver Island was the transport costs to the island. This confirms the findings of previous tourism studies which show for many prospective tourists it is the cost of transportation that represents a foremost hurdle which needs to be considered before any travel decision is made (Stevens, 1992).

When the respondents were asked about a 20 percent increase in ferry prices, 60.7 percent said it would lead to a decrease in travel between the mainland and Vancouver Island [Figure 1]. For 33.9 percent it would mean a “significant decrease’ in the number of trips taken. However, overall the anticipated reduction in round trips would be 1.4 trips on average (st. dev. = 1.66). It was felt that these reactions to a price increase would be related to the respondents’ level of income. Income levels were thought to influence tourist responses to the projected price increases, but a one-way ANOVA revealed no such relationship.

When the respondents considered a 20 percent reduction in ferry prices, 66.2 percent said they would increase the number of trips taken [Figure 2]. On average, the estimated number of annual trips increased by 1.9 trips (st. dev. = 1.65). In this case the number of respondents making a positive adjustment was higher than the negative adjustment in Figure 1, but most of the respondents anticipated a more moderate change compared to the more drastic changes associated with a price increase. However, the change in number of round-trips was higher than in the case of higher fares, with two extra trips predicted if prices were lowered by 20 percent.

If the responses to the two price situations (shown in Figures 1 & 2) are examined together it is apparent that the demand for ferry travel is elastic, but not uniformly so. Price elasticity ratios, when calculated using the formula below (Kotler et. al., 1996, p. 387), compare the proportion of change in demand with the proportion of change in price. For example if demand falls by 5% with a 5% increase in price, then the elasticity ratio is –1.0. In this case the seller’s total revenue stays the same, with 5% fewer items sold at a 5% higher price preserving the same total revenue. Elasticity ratios of 1* or less typify inelastic demand, whereas ratios > 1* underscore an elastic response and a price sensitive market (*absolute value).

Figure 3 shows how the 20 percent fare decrease would raise the number of trips across the Strait of Georgia from the current number of 3.1 round trips a year they made last year to 5.1, and a 20 percent fare increase down to 1.7 trips a year. A slightly shallower change with the increase compared to the decrease. When elasticity ratio’s are calculated, they imply that a fare decrease (ratio = +3.01) is likely to produce greater positive change than the negative impacts associated with a price increase (ratio = -2.24). This inconsistency does raise an initial question about response bias and the internal validity of tourist estimations. However, the contrast also holds intriguing possibilities for price promotion, as future subsidies in the form of a price decrease may stimulate demand to the point where an overall increase in revenue would more than cover the cost of the promotion. A breakeven analysis would be required here for the ferry service to accurately determine when the necessary level of demand had been reached.

Explanation / Answer

Highly elastic demand : In the actual scenario, the price elasticity of demand of tourism service with ferry transportation charges is highly elastic. This means that the change in ferry trasnportation charges brings about a large change in the demand of tourism services. This is the raeson, there would be high level of tourism when the ferry transportation price is low.

In this case, a decrease in ferry transportation charges brings about a large increase in demand of tourism and thus it is highly elastic. On the other hand, a decrease in ferry transportation charges does not bring about much increase in demand of tourism and thus it is inelastic.

So it is a better option to reduce the ferry transporattion chanrges which would increase the level of tourism and thus the overall revenue generation would be more for the tourism department.

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