Price Elasticity: Optimum entrance fee part 3

This is part 3 about the optimum entrance fee. This post elaborates on my previous posts about the optimum entrance fee. A lot of you probably know the basics of Price elasticity. And even if you don’t know anything about it you experience your own price elasticity a lot of times.

A perfect everyday example is the rising worldwide gas prices. A few days ago I bought a (big) Volvo. I went to the petrol station to fill up my car. When the car was filled up I went to cashier. I was in a shock when I heard the amount I had to pay. It was 74 euro’s (108 us dollars) for about 47 liters (12 gallons) of gasoline. Next time when I take the car I will think twice about it. Those high gas prices make me reconsider using my car. This approximately how basic price elasticity (of demand) works.

‘A certain percentage change in the price of a product/service changes a certain percentage of the demand for that product/service.’

The elasticity depends of course on the offered product. I am reconsidering buying gas for my car but would I ever reconsider buying drinking water…even if the price gets sky high? Probably not, water is a basic need and without I will die. How does this work with Museums? According to this article by Frey and Meier a raise in admittance fee doesn’t effect the admittance very much. Actually research suggests that a raise of 10% only suppresses demand with 2% (the elasticity is 0,2). The demand for museums is inelastic. The opposite of inelastic demand is elastic demand. The demand for a good is relatively elastic when the quantity demanded does change much with the price change. An example could be a luxurious product like a Shirt with a small crocodile on it. When they raise their prices with 10%, demand could for example drop with 15%. The elasticity of this product is 1,5. This means:

– Inelastic demand; Elasticity has a value between 0 and 1.
– Elastic demand; Elasticity has a value between 1 and infinity.

How would this work out for a museum. A museum in Amsterdam has an entrance fee of 8 euro’s (for this case there are no special prices or discounts). They have 100.000 visitors a year. Management of the museum is short on cash. The president of the museum wants build a new exhibition hall and needs extra money to finance it. The president gives the marketeer director the assignment to set the entrance fee at their optimum revenue level. His exact words were “Show me the money!”. The marketing director of this museum knows about inelasticity of 0,2 of museum admittance prices. He takes out his excel spreadsheet and comes up with the table and chart underneath. To get the highest revenue the museum should set it’s price at 24 euro’s. Attendance will drop by 40.000 to 60.000 a year.

Is it that simple? Just raise your prices until you get the highest revenue. Actually it is not that simple. Price elasticity is determined by several factors.

Frey and Meier wrote in their paper that: ‘Zoos, science museums and natural history museums show the largest price sensitivity (compared to art museums), probably due to stronger competition from other leisure pursuits.’ What thy are saying is that price elasticity depends on substitutes. A museum can set his price as high as it wants. But museum visitors will compare the prices with other leisure activities like going to the cinema or going to an amusement park. If a museum sets a relative higher price than those activities, visitors attendance will decline progressively. And it also works the other way around. A low admittance fee will also raise attendance progressively.

Time is a factor that influences price elasticity. People remember old prices better when the prices are just raised. So raising prices too much will make visitors stay away because of the big difference between the old price and the new price.

Another factor is income: someone with a low income will respond more drastically when a price changes then someone with a high income. Most of the museum visitors have high incomes so a price change will not influence their demand very much. To help low incomes attending a museum most museums differentiate their prices between high and low income (f.e. student passes).

And finally, permanent or temporary price change: a one-day sale will result in a different response than a permanent price decrease of the same magnitude.

I want to end with some concluding remarks. Price elasticity is an important factor in setting the right price. If a museum management is very keen on raising revenues they should raise their entrance fees every year a bit. The demand for museums is very inelastic and most of the museum consumers have high incomes. But while setting the price they should consider substitutes and offer a good solution to low incomes.

Other Sources:
wikipedia price elasticity of demand price elasticity of demand
Net MBA business knowledge center